In April 2021, the Biden administration released its American Families Plan, outlining its intentions to drastically alter current tax laws. Most notable among the new set of rules are proposals to reduce estate and gift tax exemption limits and eliminate the step-up in basis at death on gifts exceeding a certain amount. If passed, the changes will significantly impact wealthy families currently benefiting from provisions under the Trump-era Tax Cuts and Jobs Act of 2017 (TCJA).
Given the current democratic hold over the U.S. Senate, the legislation looks likely to pass. With the changes set to take effect on December 31, 2021, many wealthy families and high-net-worth individuals are scrambling to revisit their estate plans and develop asset protection strategies before the year’s end.
Current Law & Biden’s New Proposed Law
The Biden administration’s proposals seek to make two key changes to the U.S. Tax Code:
1) Reducing the estate and gift tax exemption amounts, and
2) Eliminating the step-up in basis rule and imposing capital gains taxes at death
Both proposals target popular wealth-preserving vehicles families use to transfer assets through generations while minimizing taxes.
Reducing the Estate and Gift Tax Exemption Limit
The current exemption limit for estate and gift taxes is $11.7 million ($23.4 million for couples), as provided by the TCJA. Transfers exceeding the maximum exemption are currently subject to a 40% tax. Absent any further legislation, TCJA provisions will sunset at the beginning of 2026.
The Biden administration intends to revert the $11.7 million exemption to its pre-2010 limit of $3.5 million ($7 million for couples), accelerating the TCJA sunset date to early 2022. The proposals would also see the top tax rate increase to 45% from 40%.
California asset protection attorney William R. Simon, Jr. serves as Chief Counsel at Sollertis, a law firm with a focus on crafting layers of legal asset protection and aligning legal strategies for wealthy individuals and families, he shares “this proposed acceleration of the gift tax limit will be devastating for those who miss the deadline and will cripple families in future years from being able to easily transfer their wealth to the next generation.”
Provisions in the TCJA have allowed families of significant wealth to transfer large portions of their assets tax-free to future generations, thereby preserving and building wealth over time. The drastically lowered threshold for exemption will result in more taxes for families at death. For example, individuals with estates valued at $5 million may soon be subject to taxes on the $1.5 million amount exceeding the new threshold.
Current gift tax law allows gifts of up to $15,000 per donee per year, affording wealthy families a method of conserving significant wealth by transferring it to several beneficiaries. Senator Bernie Sanders’ “For the 99.5% Act” would see the annual gift tax exemption limit lowered to $10,000 per donee, and the lifetime exemption for gifts fall to $1 million. If passed, the legislation would separate the currently-unified estate and gift taxes.
Eliminating the Step-Up in Basis Rule
Heirs currently benefit from the step-up in basis rule, whereby the value of an inherited asset is “stepped up” to its current market value at the time of the decedent’s death. Through this provision, any asset value accrued from when it was purchased until the decedent’s passing effectively vanishes.
Capital gains taxes are currently only levied on any increase in value between the decedent’s date of death and the date the asset is sold, should the heir decide to sell it. This rule has helped many wealthy families build wealth by offering a loophole to avoid paying taxes on appreciating assets.
The Biden administration proposes eliminating the step-up in basis for gains exceeding $1 million ($2.5 million for couples), meaning capital gains would be realized on years of accumulated appreciation. The top capital gains rate may also skyrocket to 43.4% from the current 23.8% under the new law.
Currently, capital gains taxes are not imposed until an asset is sold. Under the Biden proposal, inherited assets may be taxed as though they were sold at death if they exceed $1 million. This rule could complicate things for heirs of an asset with years or even decades of appreciation, who may become subject to a heavy tax on the unrealized gain at death regardless of whether they choose to sell the asset.
The Opportunity Now
Many wealthy families are taking advantage of the current favorable tax climate to develop strategies to help them preserve their wealth in the face of the Biden administration’s proposals.
Due to economic uncertainty caused by the COVID-19 pandemic, many asset values are depressed. Current low market values coupled with historically low-interest rates mean the current moment presents a unique opportunity for individuals to transfer assets at a low cost.
Additionally, individuals may want to take advantage of current tax provisions that may be eliminated in the coming year if new legislation is passed.
For example, interests in LLC or partnership businesses may currently receive valuation discounts, typically between 20 to 40%. With a valuation discount, interest in an entity, including entities funded with non-business assets, for estate and gift tax purposes may be given a value below its full market value. The House Ways and Means Committee proposal seeks to eliminate valuation discounts for interests in entities funded with non-business assets.
Considering that many favorable provisions may soon disappear, now may be the time to strike while the iron is hot and gift high-value assets to protect them from increased taxes.
Asset Transfer and Asset Protection
Most wealthy individuals know that asset transfers and estate planning goals can take months and involve many complex processes to change ownership of assets and obtain asset appraisals.
With the new changes to the tax code potentially coming into effect at the end of 2021, the clock is ticking for individuals to reap the benefits of today’s more favorable tax laws. Asset protection attorney William R. Simon, Jr. of the law firm Sollertis, says “we don’t know what next year will look like, or the years after that, so I’m advising some of my clients to take advantage of the current tax regulations and complete asset transfers before the end of the year…”
If you have an appreciating asset, gifting it now can help you preserve a significant amount of wealth. Not only will you avoid the potential of a drastically lowered gift tax threshold in 2022, but any appreciation the asset accrues will also be removed from your estate and thus not be subject to taxes. Additionally, making a gift before the end of this year allows you to avoid taxes on capital gains unrealized at death if the step-up in basis is eliminated in 2022.
In light of imminent estate and gift taxes changes, wealthy individuals are also turning to trusts as an asset protection method. Families are taking advantage of trusts that allow for the transfer of assets with little to no tax, such as grantor retained annuity trusts and charitable lead annuity trusts.
In an irrevocable trust, both types of trusts secure assets with potential for high appreciation, such as business assets or securities. In a grantor retained annuity trust, payments are made to the grantor for a designated period, after which assets will be transferred to heirs. In a charitable lead annuity trust, income is passed to a charity for a limited period of time before remaining assets are passed to an heir.
These methods effectively freeze the value of the estate assets, allowing for the potential future appreciation of the assets to be transferred to beneficiaries free of tax. If you are considering securing assets in a trust, you may want to consult with an experienced asset protection attorney beforehand.
There is Still Time to Take Advantage of Current Tax Law
To take advantage of current tax laws, individuals may want to consider making a taxable gift as soon as possible. Doing so will effectively make the current tax laws permanent, as gifts are reported in the year they are made, and the current tax law will apply.
The IRS has indicated that individuals who make a taxable gift up to $11.7 million while current law applies will not be subject to claw backs if the gift tax exemption falls to $3.5 million.
If passed, Biden’s proposals will result in significantly higher taxes on wealthy families and high-net-worth individuals. Given the now unique opportunity to take advantage of low market valuations and a relatively high gift tax exemption threshold, individuals should consider revamping their estate plan strategy and transferring assets before the year’s close.
