Election day 2020 is just around the corner. As we know all too well, trying to predict election results can be an exercise in futility. Estate planning clients need their trusted advisors to timely counsel them on how the election may impact their legacy planning.
The results of the upcoming 2020 presidential and congressional elections will have far-reaching tax implications on family wealth transfers. Pundits are predicting changes in the estate tax law under a Biden presidency and a Senate controlled by the Democrats. There is concern that the White House and Congress could flip to Democratic control resulting in a “Blue Wave” that will give the Democrats power to pass a sweeping tax reform.
The estate tax is a key issue on which the Republicans and Democrats disagree considerably. This means that the results of the upcoming elections will likely dictate how the estate tax is structured in the future. Since most estate plans have been created to minimize estate tax under current law, a change in the laws could mean many taxpayers will need to revise their plans and take action quickly.
It is unclear which way the election will go or what, if any, tax reform will pass. Tax reform is a complex and time consuming process. While it’s not clear what the estate tax regime will look like in the future, we do know the current laws that will be in place for the remainder of 2020. According to “anti-clawback” regulations published by the IRS, gifts made using today’s high exemption amounts are protected from future tax when the exemption amounts are reduced. These regulations offer a major incentive to use the high exemption amounts before they are reduced. Those with larger estates who could be affected may want to start planning now so they are well positioned to make gifts if the lifetime exemption drastically decreases.
As for 2021 and beyond, the estate planning landscape is likely to become less sure, so the next several months may be the best opportunity to plan with certainty.
Republican vs. Democrat Plans
Lifetime Exemption
The candidates’ policy approaches to tax rates, deductions and exemptions differ significantly. President Trump intends to make permanent the 2017 Tax Cuts and Jobs Act (TCJA) and proposes a further middle-class tax cut. Former Vice President Biden is intent on rolling back the TCJA, reverting to “historical norms” and implementing certain tax increases and expanded deductions.
The current lifetime estate exclusion amount is $11,580,000 per taxpayer, or $23,160,000 for a married couple. Estates in excess of the exclusion are currently taxed at 40%.
Joe Biden has indicated he would support legislation that would reduce the estate and GST tax exemptions to $3.5 million and would lower the lifetime federal gift tax exemption to $1 million. In addition to reduced exemption amounts, a number of Democrat proposals have discussed returning estate taxes to “historical norms.” It is unclear what “return to historical norms” means specifically. As far as timing of legislative action, some commentators believe that the increased exemption may revert earlier than Jan. 1, 2026, even as early as Jan. 1, 2021. The difference between the current exemption and the “historical norm” that may be in place in 2021 could be approximately $6 million per person or $12 million for a married couple.
Repeal of Basis Step Up
Current law also allows for a step-up in basis on appreciated property if held until the owner dies. This allows for the appreciated property to be sold or liquidated by heirs shortly after the death of an individual with little to no capital gains on the sale. Biden has proposed to repeal stepped-up basis at death, which could either mean heirs receive carryover basis and may have to plan around low-basis assets, or even that the estate will realize capital gains on the decedent’s passing, thus making the capital gains tax due immediately. In either event, elimination of stepped-up basis will result in increased capital gains taxes for those that inherit the assets.
Increased Capital Gain Rate
Under the current law, capital gains are taxed as ordinary income if those gains are realized on property held for less than one year. For long-term capital gains (gains on property held one year or longer), there is a graduated tax rate (0%, 15% and 20%) depending on the taxpayer’s income bracket. The current maximum long-term capital gains tax rate for 2020 is 20% plus a 3.8% Net Investment Income tax. Biden has proposed a 39.6% long-term capital gains tax rate on individuals earning more than $1 million per year. If the law retains the 3.8% surtax on net investment income, the effective federal tax rate on long-term capital gains could reach over 43%.
If these capital gains and estate tax changes are implemented, many estates could see significant tax bills at the decedent’s death.
Look at Your Options Now
The burning question is what actions should clients take right now in anticipation of potential tax increases? It is possible a Democratic sweep may lead to increased taxes in 2021 and would enable Democrats to take action immediately.
Regardless of the election outcome, the possibility of higher future taxes and lower exemptions suggests it is beneficial to think through your options and contingency plans now for actions that can be implemented after the election.
Currently, there is an $11,580,000 exemption from gift and estate tax. For those able to easily gift this amount, either outright or in trust, clients are encouraged to do so before the exemption changes. Taking this action is independent of the November elections because the exemption is scheduled to sunset to half of this amount on Dec. 31, 2025 ($5,000,000 increased by inflation). Therefore, if clients do not take advantage of this exemption as soon as possible, they could lose it. The reduction in the federal estate tax exemption will impact those individuals who expect to have an estate at death in excess of $5,600,000 and married couples who expect to have a combined estate in excess of $11,200,000. For these people, the loss of the increased exemption under the TCJA will result in an increase in federal estate tax at death.
There are gifting strategies to use the current increased exemption before it is lost. Generally, to use the exemption, you must make a gift of property. The planning options range from straight-forward gifts to your children or grandchildren to sales or gifts to various types of trusts. Each type of trust has a different purpose and different characteristics. Even if you do not make any large gifts, it is possible to implement other strategies to remove future appreciation from your estate so the appreciation is not subject to the 40% estate tax at your death. Grantor Retained Annuity Trusts (GRATs), making a loan to an irrevocable trust, or setting up a Spousal Limited Access Trust (SLAT) and other similar strategies work particularly well in this low-interest rate environment. These strategies may also preserve access to the underlying capital, should you need it, and minimize any taxable gifts that consume your estate tax exemption.
Whatever strategy is implemented, the only way to take advantage of the part of the current exemption that could be lost is to gift property in excess of $5,600,000. Gifts below that threshold will not preserve the increased exemption.
Start Planning Now
We highly encourage our clients who believe that they may have an estate above or near the possible reduced exemptions of $5,600,000 for an individual or $11,200,000 for a married couple to sit down with their professional advisors and discuss their options before the election. We can explain the different gifting strategies in detail to see if there is a planning option that is right for you.
Some individuals have decided to put off gifting their assets because they are concerned with not having enough income to live off of following such a transfer. Before you make any significant gift, you should do some modeling analysis and determine whether your assets are sufficient to support your lifestyle.
In order to avoid the stress of last-minute changes to your estate planning documents at the end of the year, we suggest you do some detailed planning now, while there is time to be intentional in your planning. In some cases, it might make sense to plan for potential transactions or estate plan changes now, but wait to execute until the results of the November elections are in the books.
If you have questions or would like to discuss further, please reach out to Wealth & Estate Planning Chair Kevin Lenhard at kjl@kjk.com or 216.736.7226.
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