During his campaign, President Biden announced a tax plan that would decrease the federal estate tax exemption from the current amount of $11.7 million to $3.5 million. In addition, his plan, if implemented, would raise the individual income, capital gains, and payroll taxes for individuals with high levels of income. Of these, the capital gains provisions, would appear to be most significant.
The exemption level through 2025 is indexed for inflation, and is $11.7 million in 2021. Transfers in excess of the exemption amounts are subject to gift or estate tax at a flat rate of 40 percent. Additionally, federal estate tax exemption “portability” remains for the moment, meaning that a surviving spouse can inherit a deceased spouse’s unused federal exemption if that election is made on the deceased spouse’s estate tax return.
Under the Tax Cuts and Jobs Ac.t these exemptions will be reduced to $5 million, indexed for inflation, effective January 1, 2026. However, the Biden administration has signaled it is possible this reduction will be made effective sooner. Also, tax exemptions could return to the 2009-level of $3.5 million, the tax rate for transfers in excess of the exemption amounts could be increased to 45 percent, and “portability” could be repealed.
If your estate plan was designed so that your bequests are linked to the estate tax exemption amount in effect at the time of your death, you should re-visit your estate planning documents as the documents may result in unintended distributions if those the exemption amounts change.
Assuming that the exemption will be reduced to $5 million, if your estate is significantly in excess of that amount you may want to consider using more than $5 million of the exemption before the reduction takes effect. If you use $6 million of the exemption prior to January 1, 2022, while you will have no exemption remaining, you will have captured $1 million of the bonus exemption.
Another benefit of lifetime gifting is that the post-gift appreciation of any amount gifted is transferred free of gift and estate tax. If, as a married individual, you are concerned about gifting at so high a level currently, you may create an exemption trust before the exemption is reduced for the benefit of your spouse. This allows you to possibly continue to benefit from the gifted assets indirectly, through your spouse, as long as you remain married. The indirect benefit of the gifted assets expires when your spouse dies.
The proposed Biden plan would increase taxes by, among other things, imposing a 12.4% payroll tax on earned income over $400,000 and increasing the maximum tax bracket income-tax rate to 39.6% from 37%. Certain income tax deductions also would be limited for individuals with income above $400,000.
The most drastic effects of Biden’s plan relate to capital gains. Under that plan, long-term capital gains would be subject to a tax of 39.6 percent on income above $1 million and the so-called “step-up” in cost-basis at death may be eliminated. The current capital gains tax rate is 20 percent tax, and upon death the cost or tax basis of the property the decedent owned individually or through a revocable trust is “stepped-up” (or down) to its fair market value at the time of death. This “step-up” in basis effectively eliminates built-in capital gains on property passing to heirs.
As a planning strategy, you could presently sell assets with large built-in capital gains currently realizing the tax on the built-in gain at the lower 20 percent rate. This could provide the secondary benefit of passing on a higher tax-basis asset to your heirs.