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It’s Time To Consider Your Estate Plan

The federal estate tax is not something that the majority of the population has had to consider, but potential changes by the Biden administration may change that.

The reason for this is because the lifetime federal estate tax exemption currently set at $11.7 million (or $23.4 million for married couples) may be reduced to $3.5 million ($7.0 million per couple). Therefore, under current law, an individual can have assets with a fair market value of $11.7 million, before being subject to estate tax, whereas under the proposed legislation, those with assets exceeding $3.5 million, would be subject to the estate tax. The proposed change will expose a greater percentage of the population to the estate tax.

By way of context, there are 1.3 million households in the United States with a net worth of at least $10.0 million, but the number of households with a net worth of at least $1.0 million is 11.8 million. That’s an increase of 10.5 million households. Given this information, it is safe to conclude that the number of households that will need to consider estate planning alternatives in light of proposed changes, will increase dramatically, should the lifetime exemption be reduced to proposed levels.

In addition to lowering the lifetime exemption, the administration has also discussed increasing the estate tax rate from its current 40% to 45%. It is noted that the $3.5 million exemption and 45% estate tax rate is the same as what was in place when Mr. Biden served as the vice-president to President Barack Obama in 2009.

Other discussions include the elimination of what is known as a “step-up in basis,” which allows for beneficiaries in an estate to disregard the cost (basis) of certain inherited assets and treat its value at the date of death (or an alternate date if chosen) as its basis. This allows the beneficiaries to pay less capital gains tax upon sale of the asset, should they choose to sell it.

Historically, when one made gifts, it made sense to gift cash and maintain ownership in assets whose value would likely continue to rise.  These included family-owned businesses, personal residences and marketable securities.  The reason for this is because upon death, the beneficiaries would receive the aforementioned step-up in basis, meaning that the value of the asset in the hands of the heirs, was determined at the date of death. So, for example, if your parents bought a house in the 1950’s for $15,000 and at the time of the death of the last parent it was worth $285,000, the beneficiaries received a “step-up” in basis to $285,000.  There is no tax impact to the increase in the value of the home at the estate level, due to the step-up in basis. Further, if the beneficiaries sold the asset at a later time for $300,000, the gain would be calculated on the difference between the $300,000 sale price and the $285,000 basis – a gain of $15,000, which would be subject to capital gain taxes.

The Biden administration’s proposed abolishment of the step-up provision causes the original basis of the asset to carry over to the beneficiaries. In the above example, a lack of step-up in basis would cause there to be a capital gain of $285,000 ($300,000 – $15,000) upon which capital gain taxes would be due.

Capital gain tax rates are also of interest to tax advisers, as a combination of the repeal of the “stepped-up basis” and a potential increase in capital gain tax rates (with some suggesting that depending on earning levels, the rate could be the highest marginal income tax rate, which has been proposed to increase to 39.6%) could cause heirs to have to sell the inherited asset in order to pay the associated tax. Add in state taxes and the 3.8% investment tax, and the total tax rate could exceed 50%.

Lastly, although separate and apart from President Biden’s proposed changes highlighted above, Senator Bernie Sanders introduced a bill co-sponsored by Senator Kristen Gillibrand and others that will negate the ability to sell assets to trusts as well as greatly diminishing the ability to use valuation discounts in the transfer of assets.

As a result, it is imperative to discuss your financial condition and estate plan with your tax adviser at Withum, so that; informed decisions can be made before tax law changes are implemented, the transfer of assets can be done in accordance with existing laws, and valuations can be prepared utilizing the appropriate discounts.

Please reach out to one of our Private Client Service leaders, Ted Nappi at tnappi@withum.com  or Hal Terr at hterr@withum.com to discuss estate tax planning. Please also feel free to reach out to me at treck@withum.com to discuss any valuation issues.

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