The 2020 election is almost upon us. The past has taught us that trying to predict the results of an election are futile at best. Still, estate planning clients need timely counsel as to how the election may impact their financial futures. Estate planning attorneys strive to help clients stay informed and suggest opportunities for clients to respond to changes. While we do not know exactly what the future holds, we do have strong clues as to what the tax laws may look like if the balance of power shifts in 2021 from Republican to Democrat hands.
Note that these changes are not necessarily dependent on the outcome of the November election. Some commentators suggest that even under a continued Republican-controlled government, many of the changes discussed below could be implemented as the nation grapples with the economic pressures brought about by the coronavirus pandemic.
Proposed Policy Adjustments Under a Biden Presidency
Here is what we know so far about some of the key proposals most relevant to estate and tax planning:
Estate, Gift, and Generation-Skipping Transfer Taxes
The Tax Cuts and Jobs Act (TCJA), signed into law by President Donald Trump on December 22, 2017, doubled the basic exclusion amount from $5 million to $10 million, indexed for inflation. In 2020, the estate and gift tax exemption is set at $11.58 million with any wealth transfer exceeding that amount being taxed at the top rate of 40%. The generation-skipping transfer (GST) tax exemption currently matches the estate and gift tax exemption. Under the TCJA, the basic exclusion amount is scheduled to reset back to $5 million in 2025 (indexed) unless new legislation is passed before then.
Former Vice President Joe Biden has suggested that if elected to the Oval Office, he would support legislation that would reduce the estate and GST tax exemptions to $3.5 million and would lower the lifetime federal gift tax exemption amount to $1 million. In addition to reduced exemption amounts, a number of Democrat proposals have discussed returning estate tax rates to “historical norms”. In 2001, estate tax rates were as high 55%, with an additional 5% for estates over $10 million. If a new Congress looks back two decades or more for transfer tax inspiration, it seems likely that we could see an upward adjustment in the transfer tax rates.
Capital Gains Taxes
Under the current law, capital gains are taxed as ordinary income if those gains are realized on property held for less than one year. For long-term capital gains (gains on property held for a year or longer), there is a graduated tax rate (0%, 15%, and 20%), depending upon the taxpayer's income bracket. Taxpayers who earn income from investments may be subject to a 3.8% net investment income tax on the lesser of their net investment income, or the amount by which their modified adjusted gross income exceeds $125,000 (married filing separately), $200,000 (single or head of household), and $250,000 (married filing jointly), in addition to the applicable capital gains tax rate.
Current law also allows for a step up in basis on appreciated property if held until the owner dies. This allows for inherited property to be sold or liquidated shortly after the death of an individual with little to no capital gains tax on the sale.
Today’s law also allows for like-kind exchanges on appreciated property such as artwork and rental properties, enabling taxpayers to reinvest the gains earned on appreciated property into similar types of property without having to pay capital gains taxes when the property is later sold. If an individual makes subsequent like-kind exchanges on appreciated property until that individual’s death, then the capital gains built up in that property will be erased by the basis step-up rules.
Proposed changes under a Biden presidency would either (1) eliminate the step-up basis rule for inherited property and impose a carryover basis rule for inherited property, or (2) impose recognition of gain on property at the death of the owner. Additionally, the Biden tax plan proposes to eliminate like-kind exchanges and impose a 39.6% long-term capital gains tax rate on individuals earning more than $1 million per year. If the law retains the 3.8% surtax on net investment income discussed above, the effective federal tax rate on long-term capital gains could reach over 43%.
If these capital gains and estate tax changes are implemented, many estates could see significant tax bills at the decedent’s death.
Learn more about this topic by registering for the 3-day webinar series, "Thriving in Estate Planning: Looking Ahead to the 2020 Election and Beyond" beginning on September 30, 2020.
How Can You Help Your Clients Prepare?
You can discuss the following important estate planning strategies with your clients today so they do not get taken by surprise should the election usher in changes:
- Grantor Retained Annuity Trust
A properly structured Grantor Retained Annuity Trust (GRAT) allows clients to transfer more property to beneficiaries at a lower gift tax value than if they were to make gifts outright to those same beneficiaries. GRATs are an excellent estate planning technique that, while available today, may be curtailed under Democratic proposals, such as a required minimum trust term of ten years. Thus, the window of opportunity for using short-term GRATs to transfer large amounts of wealth at a significant discount may soon be closing.
- Installment Sale to Intentionally Defective Grantor Trust
Clients with income-generating real property or business interests that are expected to appreciate can freeze the value for estate tax purposes. An installment sale to an Intentionally Defective Grantor Trust (IDGT) allows a client to sell appreciating property such as real estate, or even a family business such as a family limited partnership, to a carefully drafted trust in return for an installment note using the currently low federal interest rate. Property in the trust must obtain a rate of return or growth in excess of the interest rate for this strategy to succeed. There is a strong chance that this favorable result can be obtained in today’s low interest rate environment. As with other grantor trusts, this strategy requires that your client be prepared to pay income tax on the income generated by the trust property.
- Spousal Lifetime Access Trust
The Spousal Lifetime Access Trust (SLAT) strategy allows a donor spouse to make a gift of property into an irrevocable trust for the benefit of the other spouse (as a beneficiary of the trust) and other beneficiaries (children or grandchildren). The trust names an independent trustee who has discretion to make distributions among the various beneficiaries. The transfer to the trust is intentionally designed to not qualify for the unlimited marital deduction so that the donor spouse’s estate exemption can be more fully utilized and the appreciation on the property transferred to the SLAT will not be subject to future gift and estate tax.
Ideal clients for a SLAT strategy are happily married couples (because the SLAT is irrevocable) who own property that is expected to significantly appreciate and who can transfer such property irrevocably without jeopardizing their current standard of living.
- Irrevocable Life Insurance Trust
Although Irrevocable Life Insurance Trusts (ILITs) have not been utilized as much recently as in the past, such a strategy is still a highly effective one—especially in an environment where the estate and gift tax exemption amounts may be reduced significantly in the near future, putting clients in a “use it or lose it” situation. This technique calls for a client to transfer property (usually cash) to an irrevocable trust. The transfer can be made all in one year and may reduce the client’s gift tax exemption to some extent. The trustee uses the cash to pay the premiums on a life insurance policy for the client. The death benefit passes to the trust income tax-free and on to the trust beneficiaries outside of the client’s estate, and therefore free of estate taxes. Your client must typically have sufficient cash reserves to contribute to the trust and be healthy enough to qualify for a life insurance policy.
Talk To Your Clients About These Changes and Strategies
Even if your clients are not ready to implement any of the above strategies before the 2020 election results are known, informing clients now of these potential planning opportunities will help them move quickly when the time comes. Educating your clients about these and other valuable wealth preservation strategies can solidify your role as an essential and trusted family advisor to multiple generations of clients.