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Clarification on Key Parts of Proposed Biden Changes to Estate & Gift Taxes

by Pam Dennett
January 28, 2021

As expected, the Biden administration has suggested a repeal of the Tax Cuts and Jobs Act (TCJA) provisions relating to estate and gift taxes. These repeals would return the lifetime exemption to approximately $5.49 million as adjusted for inflation or possibly reduce it even further to $3.5 million per person for the estate tax and $1 million per person for the gift tax. Also, the tax rate could be increased from 40% to 45%. These changes could be retroactive to January 1, 2021.

Biden also proposed repealing the current law that allows for assets to be either stepped up or stepped down to the fair market value as of the date of death, resulting in a new tax basis. In other words, a decedent’s heirs would take the same tax basis as the decedent had prior to death (carryover basis). This would be a huge blow to families who have been planning on passing low basis assets at death. Without the step up in basis, there will be capital gains when those assets are disposed. Under the Biden plan, those capital gains could now be taxed at the top marginal tax bracket of 39.6% for taxpayers with taxable income over $1 million.

Even if the Biden administration does not change the estate tax laws right away, the current estate and gift tax regime is temporary and currently set to expire on January 1, 2026, which will result in a decrease in the lifetime exemption to approximately $6 million per person as adjusted for inflation.

Clarification of Misunderstood Changes

With so much information in the media and on the internet, it can be overwhelming and difficult to understand what these potential changes mean and how to act before it is too late. Many taxpayers have misunderstood Biden’s suggestions.

Below are the most commons points that have been misinterpreted:

  1. When we say use it or lose it, we mean it! A taxpayer who has $11.7 million of exemption available today (meaning they have used zero to date) may have $3.5 million of exemption remaining if Biden’s plan passes. What some taxpayers do not understand is if they have used some of their exemption on lifetime gifts, that will reduce the amount they have left under Biden’s plan. For example, assume a taxpayer has made lifetime gifts that amount to $4 million of their exemption. If Biden’s plan is passed, that taxpayer would have zero exemption remaining. In other words, if you do not use what you have available today, you will lose it.
  2. Changes could be made retroactive to January 1, 2021. It is hard to believe that any change to the tax laws could be retroactive, but we should assume this could happen. If a taxpayer has not used any lifetime exemption to date and then decides to make a $5 million gift tomorrow and then Congress agrees the estate and gift tax changes will be retroactive to January 1, 2021, a portion of this gift would be subject to gift tax. If the exemption were to be reduced to $3.5 million, then $1.5 million of this gift would be subject to the gift tax at a potential rate of 45%.
    Although it may seem unlikely that Congress would penalize taxpayers for estate tax planning in 2021, we cannot rule out the possibility of retroactive treatment. There is some precedent in previous court cases to support retroactive changes in the tax laws. However, many of the top estate planning attorneys in the country are discussing techniques that can be used to take advantage of last-minute gifting in 2021 while avoiding the gift tax if the changes are retroactive to January 1, 2021.
  3. The IRS will claw back used gift exemptions. Many taxpayers have wondered if they could ever be subject to gift tax or estate tax on lifetime gifts they made during the years the exemption has been at its highest ($11.7 million currently). This provision is referred to as a clawback of the gifts. The answer is very clear since the IRS published final regulations in November 2019, which included anti-clawback rules.
    Under these rules, once a taxpayer has used their lifetime exemption, the IRS cannot “claw” any of those gifts back into their estate simply because the lifetime exemptions are subsequently reduced. If a taxpayer gifts $11.7 million today and then dies in 2023 (assuming the lifetime estate exemption is $3.5 million at that time), they will have zero exemption remaining at their death. However, none of the previously gifted amounts will be pulled back into their estate.
  4. It will take time for Congress to agree on any changes to the tax laws. Not necessarily — Janet Yellen was confirmed as the new Secretary of Treasury on January 25 and has suggested accelerating tax legislation and plans to fast track tax increases, including those related to the estate tax regime. Taxpayers may not have the rest of 2021 to decide whether to use the increased lifetime exemption. Although a change in tax legislation may not be retroactive to January 1, 2021, it certainly could be effective on the date the new law is enacted, such as June 1, 2021, if not sooner. For that reason, it is imperative taxpayers use this increased exemption in the next few months.
  5. Could taxpayers really lose the step-up in basis at death? Yes, it is very possible under Biden’s plan that the laws which provide for a new tax basis in assets at someone’s death are eliminated. If this provision were to pass, the idea of selling a low basis asset and then gifting the cash might be more appealing for certain high-net-worth individuals.
    A parent might be better off paying the capital gains tax on the sale of an asset and then giving the full cash proceeds to the child rather than giving the child an asset with a low tax basis. Anytime a parent pays the income tax on assets that have been gifted or will be gifted, the payment of the income tax is basically a tax-free gift because it is not treated as a gift. Also, the payment of income tax by the parent removes that cash from their estate, which automatically saves them from paying the estate tax at a 40% or potentially 45% rate.

For more information on income and estate tax planning strategies to consider right now, see our recent article on last-minute tax planning ideas. If you have any questions or need assistance, contact our experts.

January 28, 2021

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