Currently, President Biden’s proposed tax plans will affect estates of $1,000,000 or more by increasing taxes on certain taxpayers, clarifying certain tax provisions and giving the IRS more resources to enforce tax laws. On May 28, the Biden administration released his current budget proposal commonly referred to as the Green Book. This proposal outlines the administration’s plan to make death, lifetime giving, and holding periods for assets in trust recognition events (tax triggering events) for income tax purposes. If passed, many of Biden’s tax reforms will impact wealthy families, professionals, and small business owners.
In this article, we will discuss those of his proposals with the most significant impact on estate planning. We will also present potential planning considerations for certain presumed proposals that were left out of the current plan that many are saying could be passed at some point in his administration.
The first change to consider is the taxing of capital gains of high-income individuals (with adjusted gross income over $1 million) at a 37% rate. This change is not currently in the Green Book but has been previously mentioned in The American Family Plan.
The next proposed changes come from the Green Book:
- Treat gifts and death as recognition events.
- Gifts, bequests, and transfers of appreciated property to trusts (other than revocable) and partnerships will be treated as recognition events for the donor. Transfers at death would also become recognition events.
- A $1 million per-person exclusion from gain. This amount is portable to a surviving spouse using the same rules for portability of the gift and estate tax purposes and would be indexed for inflation.
- Additional exclusions include tangible property, qualified small business stock (QSBS), and losses that are available to offset gain with respect to transfers at death.
- Transfers at death to a “U.S. spouse” wouldn’t be a recognition event with the decedent’s tax basis carrying over to the surviving spouse.
- The proposal similarly exempts transfers from decedents to charity.
- A donee’s basis from property that was subject to a recognition event will become the fair market value (FMV) at the time of recognition. The Biden proposal doesn’t provide a basis adjustment for property shielded from recognition by the $1 million exclusion and the donor’s basis will carry over to the donee.
- The proposal allows for a 15-year payment plan on the tax liability for all nonliquid assets. It also allows for an indefinite deferral for family-owned and operated businesses that will be due only when no longer family-owned and operated.
- Events deemed recognition events will be reported on the donor’s gift tax return or decedent’s estate tax return, or potentially on a separate capital gains return.
- The Biden proposal is calling for these gain recognition provisions to apply for all gifts and deaths occurring in 2022 or later.
- Assets held in non-grantor trusts will be deemed recognition events every 21 years and apply to all property irrespective of its holding period.
- President Biden’s proposal would start counting 90 years from Jan. 1, 1940, meaning that a trust that was in existence in 1940 or earlier that has property not subject to a recognition event will have it recognized no later than Dec. 31, 2030.
- While what is being proposed doesn’t directly attack the transfer tax regime, it would curtail the benefits and flexibility of planning with intentionally defective grantor trusts (IDGTs). As currently stated in the proposal, these transfers are triggered as recognition events.
- Grantor trusts that are wholly owned and revocable by the grantor will not create a recognition event.
- Included as a reporting requirement in the proposal requires all trusts with more than $1 million of assets or $20,000 of income to provide a balance sheet, income statement and complete accounting of all trust activities and operations for the year.
There are a few additional proposals that have been mentioned previously, however, were left out of the May 28 edition of Biden’s Green Book. These include reducing the gift and estate tax exemption and the elimination of step-in basis which states when capital assets are inherited, the basis (cost) is generally “stepped-up” (updated) to the date of death of the decedent. Eliminating the step-up is worrisome for individuals and families holding highly appreciated assets since those assets could be subject to both estate and income taxes upon death.
If a reduction of the gift and estate tax exemption amount and elimination of step-up in basis would come to fruition during Biden’s administration, the following are proactive planning considerations:
- Annual gifting: Current limits allow for gifts up to $15,000 per donee per year, a strategy used to pass wealth while staying within IRS limits. More importantly, gift up to the current exemption amount of $11.7 million per person now. It is possible to use the full exemption limit ($11.7 million) even if it is lowered to $3.5 million. The IRS has confirmed that it will not claw back tax on lifetime gifts if the exemption is subsequently lowered. By executing a gift now, you not only save on potential gift and estate taxes but the future asset appreciation is removed from your estate. In addition, if the proposed imposition of a capital gains tax on gifts made after 2021 becomes law, making a gift in 2021 instead of 2022 will avoid a capital gains tax.
- Use of SLATs (Spousal Lifetime Access Trusts): SLAT is a trust where one spouse (the donor spouse) creates an irrevocable trust for the benefit of his or her spouse. It provides direct access for the beneficiary spouse and indirect access for a donor spouse. This type of gift allows you to remain in control of your assets.
- Gifting of highly appreciated assets: Along with gifting cash, families may consider gifts of stock to beneficiaries during one’s lifetime. Lowering the amount of the taxable estate can be compelling when beneficiaries have lower capital gain tax rates. Also, consider gifting these assets into an irrevocable trust for their benefit.
- Life Insurance: When structured and executed appropriately (meaning use of an irrevocable life insurance trust (ILIT) to hold the policy which keeps it out of your estate), certain types of insurance products may provide the liquidity needed to pay for any taxes at death. This may come into play if an immediate income tax on death is imposed.
Estate and gift taxation are a significant factor as families plan for the future. The estate planning process can take several months and involve many components such as development of goals and objectives, execution of legal documents, changing ownership of assets and asset appraisals. Implementation now can help prevent the stress of last-minute decisions and increased costs. Gift planning that includes privately held business interests will require valuation of the entity for gift tax purposes as well as computing discounts for lack of control and marketability. The use of qualified valuation professionals will ensure that the valuation used for gift tax purposes is respected by the IRS and not subject to a future challenge. Get in touch with us now to start the planning.