2021 has been an interesting year thus far. COVID-19 seems to be waning, markets are continuing their rebound, and Washington has been busy. It should come as little surprise that Congress seeks ways to generate revenue given current spending levels. This is usually when chatter picks up regarding tax transfers and this year is no different; if anything, the stakes are even higher. So what has been proposed and how might it affect high net worth estate and gift planning?

Proposal to Lower the Federal Estate Tax Exemption

Families with a net worth of more than $7 million ($3.5 million for individuals) will need to examine the proposed lowered federal estate tax exemption. It is currently $11.7 million per person, and had been increased as part of the Tax Cuts and Jobs Act of 2017. Current exemption amounts are already intended to sunset at the end of 2025 and return to their pre-TCJA levels. On top of this, the Biden administration and the Senate have proposed reducing the exemption to $3.5 million per individual, thus generating potential federal revenue as early as next year.

One potential bright spot that has not changed is the unlimited marital deduction. This means taxpayers can transfer 100 percent of their wealth, tax-free, to a surviving spouse upon death. The spouse would then include the decedent’s assets as their own and include that amount in their estate.

The current federal estate tax rate tops off at 40 percent. Proposed changes include an increase to 45%. To put in perspective for high-net-worth taxpayers, an estate of $20 million today would owe approximately $3.32 million in federal taxes. If these proposals go into effect as worded, that same estate would owe approximately $7.425 million in federal taxes.

Looking back at historical exemption levels shows that the exemption has never been lowered, which provides for an interesting consideration. If a taxpayer with considerable assets would like to take advantage of the current (high) exemption of over $11 million, they could gift this amount (or whatever the current exemption is once lifetime gifts are taken into consideration) to loved ones. If the exemption is lowered, they have locked in the higher exemption with no tax consequence.

This should require considerable thought as this must be a gift as defined by the IRS. The IRS views gifts as “any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money’s worth) is not received in return.”

Speaking plainly, taxpayers must be willing to part with millions of dollars without the expectation of seeing that money again. Gifts may be made in several ways, whether to irrevocable trusts or outright gifts. The use of Grantor Retained Annuity Trusts, which take advantage of current low-interest rates, may also be advantageous.

For more information on gifting strategies, please visit our previous Insight: Wealth Transfers in a Low-Interest Rate Environment.

Eliminating the Step-up in Basis

There has also been chatter of eliminating the step-up in basis that heirs receive upon inheriting assets.

In taxable accounts, for investments that have been held and that have considerable gains, there are embedded unrealized gains that would be realized upon the sale of such investment. Some individuals decide to hold on to these investments rather than sell them and pay taxes. Once the taxpayer passes away, heirs may receive these assets with the basis adjusted to the date of death, thereby avoiding the embedded unrealized gain that would have been paid if the taxpayer were still alive.

The Biden administration believes this would generate potentially billions in federal income. Eliminating the step-up in basis would only apply to gains of $1 million or more ($2 million for married couples). If the taxable portfolio contains a large amount of unrealized gains, it may be advantageous to look at this now. Perhaps considering a charitable gift using this investment could be prudent rather than holding on to it for the sake of avoiding capital gains.

These proposals are by no means written in stone (or law). They will likely face opposition, though it is beneficial to at least review the estate and gift situation and begin a conversation with a financial advisor if these potential changes may adversely affect the estate plan or long-term financial goals.

Questions? Contact Shelly Braden today.

About the Author:

Shelly Braden - PBMares WealthShelly Braden, CFP®, BFA™
Senior Wealth Advisor

As a Certified Financial Planner™, Shelly specializes in coupling comprehensive financial planning with an estate planning focus. She holds a Master’s in Financial Planning & Taxation with a concentration in Estate Planning.