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Potential New Regulations and How they May Impact Your Estate Planning Strategies

With new administration in the White House, upcoming changes have the potential to affect your 2021 estate planning. President Biden’s proposal includes four main changes that may have estate tax planning implications:

  1. Reducing the Lifetime Estate/Gift Tax Exemption

The lifetime estate/gift tax exemption refers to the total value of assets you may gift during your lifetime or leave following your death that is free from federal gift or estate tax.1

Currently, the exemption is $11.7 million per individual ($23.4 per married couple filing jointly), but that amount is set to sunset on December 31, 2025, and return to the prior exemption of $5 million per person. If adjusted for inflation, this amount would likely be between $6 and $7 million.

The president has informally proposed a decrease in the federal estate and gift tax exemption amount to either $5 million per individual ($10 million per married couple) or to the pre-Tax Cuts and Job Acts rate of $3.5 million per individual ($7 million per married couple).

  1. Increasing the Estate Tax Rate

In addition to decreasing the lifetime exemption, the Biden administration could raise the estate tax rate to 43 percent. Some accounts indicate that a tiered tax rate scale may be implemented, with incremental tax rates as high as 70 percent for very large estates.2

  1. Eliminating the Step-Up in Basis

As a corollary to the estate tax, assets generally receive a step-up in basis following the owner’s death, regardless of whether or not taxes are due. This means that the tax basis of the asset is adjusted to fair market value at the time of the owner’s death. This allows a beneficiary to sell an inherited asset without recognizing any gain on pre-death appreciation.

There is talk of repealing the step-up in basis, which means beneficiaries would not receive a new tax basis equal to the date-of-death value. As a result, beneficiaries would pay capital gains taxes on all appreciation, both pre- and post-death, upon the sale of inherited assets.

Other countries impose a capital gains tax at death in lieu of an estate tax. At the time of death, any built-in gain is taxed. There is a small chance this approach could be adopted in the United States.

It’s also possible to adopt a provision that allows beneficiaries to choose which type of tax structure applies to their inheritance. Such a benefit was in place in 2010 and was supposedly utilized by the Steinbrenner family to transfer the Yankees estate tax free following George’s death.

  1. Raising the Capital Gains Rates

It is possible that capital gains rates will be raised to an amount similar to ordinary tax rates. In which case, estate tax planning may become undesirable for low basis assets in some cases. Most transactions that remove an asset from an estate will, as a corollary, prevent a step-up in basis for the asset upon the owner’s death. If the estate tax rate is significantly more than the capital gains rate, it makes sense to engage in transactions that avoid estate tax, even if there is a loss of the step-up. As the spread between the estate tax rate and the capital gains rate shrinks, it often makes less sense to avoid estate tax at the cost of losing the step-up.

Given these proposed changes, we are left with three main questions:

  1. What is the likelihood of enacting these changes?

Even with Democratic control of the House and Senate, including the tax bill writing committees, there are certain Congressional hurdles that any proposed changes will need to overcome, and the balance of power still comes into play. Those opposed to President Biden’s plan pushback and negotiations are likely