If you have a multimillion dollar estate you may be impacted by the Biden administration’s proposed wealth tax. Owners of large estates could see more than half of their total estate pass to the government rather than their heirs. However, there are still planning opportunities to avoid the traps of the estate tax and the dreaded elimination of the “step-up” in basis.
With the release of the Treasury Department’s 114-page “green-book” we now have a better picture of the Biden administration’s proposed tax increases– specifically, those proposals that may impact your estate planning. This article will breakdown that plan and show you what you need to be discussing now with your Withum tax advisor to avoid the inevitable increases in taxes.
What’s in The Proposal?
The Treasury Department’s General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, commonly referred to as the “Green Book”, lays out the administration’s plans to amend the Internal Revenue Code (IRC) to meet their legislative agenda. However, it’s important to note that these are all proposals and would only become law if it was passed by both chambers of congress and signed by the president. Here are some of the major proposals that are in the president’s plan:
- Increase the top marginal individual income tax rate from 37 percent to 39.6 percent
- Tax Long-term capital gains and qualified dividends of taxpayers with adjusted gross income of more than $1 million at ordinary income tax rates (top rate of 40.8 percent including the net investment income tax)
- Gifts or inheritance of an appreciated asset would be subject to a capital gain tax at the time of the transfer by the donor or decedent
- Gain on unrealized appreciation of assets would be recognized by a trust, partnership, or other non-corporate entity every 90 years starting on January 1, 1940 (First tax would be triggered December 31, 2030)
- Transfers of property into, and distributions of property from, a trust, partnership, or other non-corporate entity that is revocable by the donor would be a recognition event which would trigger capital gains if the distribution were to a person other than the deemed owner or his/her spouse. In addition, distributions from a defective grantor trust to someone other than the grantor while the grantor is alive would subject to the deemed sale rule as well.
Certain exclusions would apply:
- Transfers by a decedent to a U.S. spouse or to charity would carry over the basis of the decedent
- Appreciated property transferred to charity would not generate a taxable capital gain
- Exclude from recognition any gain on tangible personal property such as household furnishings and personal effects (excluding collectibles)
- $250,000 per person capital gain exclusion from the sale of a primary residence would still apply
- Exclusion for capital gain on certain small business stock would still apply
- $1 million per-person exclusion from recognition of other unrealized capital gains on property transferred by gift or held at death
- Payment of tax on the appreciation of certain family-owned and -operated businesses would not be due until the interest in the business is sold or the business ceases to be family-owned and operated.
The major takeaway from the proposals is that wealth is going to be taxed within a taxpayer’s lifetime or subsequently after their death. Historically, the key planning strategies for tax accountants has been to defer, defer and defer but these proposals would look to limit or ultimately stop taxpayers from deferring tax on generational wealth.
As we know IRC section 61 taxpayers are required to include all income, from whatever source derived as part of their gross income – including any accession to wealth. However, unrealized gains and inherited property have been historically treated as non-taxable with the added bonus of a step-up in basis.
The reason why a step-up in basis exist is to avoid double taxation between the estate tax and federal income tax. Without IRC 1041 an estate would be taxed once it’s passed onto the next generation and again when the property is sold by the beneficiaries.
What this proposal does is tax appreciated assets when it is gifted, sold, inherited or held for more than 90 years – essentially eliminating any chance of deferring tax on unrealized capital gains.
ready to help you implement the best estate planning strategies that work best in the current estate tax environment.
Now that we’ve gone through the proposals and explained how they may impact your estate it’s important to note that these are just proposals and it’s unlikely that they will be signed into law in their current state. There is a narrow path to pass any major tax reform and any package that eventually gets passed will inevitably be filled with revisions.
However, assuming these proposals do become law there are some planning opportunities:
Use up Current Lifetime Exemptions
The Tax Cuts and Jobs Act (TCJA) increased the federal gift, estate and GST tax to $11,700,000 as of January 1, 2021 ($23,400,000 for a married couple), allowing individuals temporary multi-generational estate planning opportunities. Taxpayers should consider using up these exemptions through lifetime gifting before the increased exemptions expire on January 1, 2026 or get reduced sooner by impending legislation. Using up this lifetime exemption now will defer a triggering of capital gains and reduces the eventual impact of the estate tax.
Another strategy that could work would be the use of intra-family loans. Currently, IRS defined interest rates on intra-family loans are near historic lows with the short-term rate for loans of up to three years below a quarter of a percent; the mid-term rate for loans of more than three years and up to nine years at just over 1 percent; and the long-term rate for loans exceeding nine years at just over 2 percent.
These loans are a great way to transfer funds to family members to purchase a home, pay for a wedding, or create investment opportunities that will grow outside of the lender’s estate. Making a loan directly to a grantor trust for your children is also a great way to avoid estate and income tax – ordinarily, interest payments on intra-family loans must be included in your taxable income, but if the payments are made by a grantor trust, they will not be included in taxable income.
Gift Cash and Other High Basis Assets
Gifting assets before they appreciate is the best way to avoid triggering higher estate tax and potentially capital gains tax in the future. By gifting assets that have a higher basis, lower current valuation with good outlooks for appreciation you will be deferring those unrealized gains for much longer. With the current back and forth in policy proposals we could see these provisions passed and then subsequently repealed by another administration so the name of the game is still – defer, defer and defer.
Use of Intentionally Defective Grantor Trusts
Selling or gifting interest in a closely held business to an Intentionally Defective Grantor Trust (IDGT) is a great way to transfer ownership of a family business without saddling the next generation with the income tax burden. The grantor will pay income generated by the trust while allowing the business interest to grow outside of their estate.
Additionally, the use of discounts (which may be eliminated through future legislation) when valuing a business interest is a great way to get the most bang for your buck when it comes to estate planning. Whether it be the sale of a minority interest in a closely held business or a fractional interest in a piece of real property, valuation discounts allow for more value to be used up by the lifetime exemption and avoid triggering capital gains before these proposals are passed.
The Time For Planning is Now
Although these provisions may be enacted retroactively, as they were under the TCJA, it’s still prime time to plan ahead. Implementing an estate plan is complex and requires several different advisors including lawyers, accountants and valuation experts.
The next major piece of legislation is expected to be passed sometime after October (the next time the Democrats can use the budget reconciliation process) so you don’t want to be scrambling for guidance while Congress is voting on a bill.
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