In this world, nothing is certain but death and taxes. The old saying from 1789 is still applicable although we can safely say there is nothing certain
about taxes these days. Tax policy is subject to the political winds. With each election cycle comes discussion of changes to tax policy along with creative legislative techniques to enact these proposals with small margins in Congress. This has created a nightmare for taxpayers and tax advisors alike.
In times of potential change and uncertainty, it is easy to become overwhelmed and indecisive. It is important to remind yourself of our current tax policies and fully explore available planning opportunities for you and your family. Once that is complete, you can then analyze proposed tax law changes and determine if those changes, if enacted, would impact your timeline or overall decision.
While no one has a crystal ball as to the future of tax policy, it is safe to say that if you have contemplated making gifts or updating your estate plan, now is the time to do a thorough review.
Current Estate Tax Law
Below is a summary of the key points of our current estate tax laws. Important to note is the “sunset” on December 31, 2025 that reduces the available estate, gift, and generation skipping tax exemption in half. This is the law as it is written today and will come into effect without any further action by Congress,
even if none of the current estate tax legislation proposals are signed into law.
- A top tax rate of 40% applies to property inherited from an estate. If a donor makes a gift during their lifetime that exceeds the annual per-donee gift tax exclusion, a top tax rate of 40% also applies to that transfer absent application of any lifetime gift tax exemption the donor has. If a donor gives property directly to grandchildren, an additional tax (generation skipping transfer tax) of 40% applies. Transfers between spouses are generally exempt from these taxes, as long as they are US citizens.
- For tax years after December 31, 2017, the first $10 million of assets, indexed for inflation ($11.7 million for 2021), are exempt from any combination of estate, gift, and generation skipping taxes. This provision that doubled the estate, gift, and generation skipping tax exemption from $5 million to $10 million per taxpayer, indexed for inflation, will expire December 31, 2025 barring additional action by Congress prior to that date. This means that on January 1, 2026 the estate tax exemption will drop back down to $5 million per taxpayer, indexed for inflation to an estimated $7.6 million, versus $11.7 million for 2021.
- The per-donee annual gift tax exclusion for gifts made during 2021 is $15,000 (this exclusion can be adjusted by the IRS annually for inflation).
- The surviving spouse may carryover any unused estate and gift tax exemption of the deceased spouse and add this portion to their own available exemption amount (portability); however, the surviving spouse may not port any generation skipping tax exemption.
- A beneficiary who receives property from an estate receives an adjustment to their basis in that property equal to the fair market value at the date of death (stepped-up basis) while a donee who receives a gift of property during the lifetime of the donor retains the original basis of the donor (carryover basis).
Other Important Tax Provisions that Sunset December 31, 2025
As mentioned previously, certain tax provisions passed as part of the Tax Cuts and Jobs Act on December 22, 2017 are set to expire December 31, 2025 and revert to previous law. This technique for passing “temporary” changes to the tax code is used to allow budget items to pass with fewer votes using complicated parliamentary rules. These “expiring” tax provisions were historically used only on minor tax items but since 2001, with the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 sunsetting in 2010, they have become a “normal” part of fiscal policy.
While there are over 20 provisions set to expire December 31, 2025, of particular note for individual taxpayers are changes that impact the reduced marginal tax rates, the increased standard deduction, the increased AMT exemption and phaseout, and the limit on state and local taxes allowed as itemized deductions.
Proposed Changes by Biden Administration
President Biden released his “Green Book” Proposals and his Fiscal Year 2022 budget in May, 2021. The “Green Book” is the summary of the Administration’s tax proposals included in their budget. While these proposals are not considered introduced legislation with this release, separately, various members of Congress that have already introduced their own bills. Some of the relevant tax rate and estate tax law changes from the Green Book and the bills already introduced are summarized below.
Biden Green Book
Proposed Changes in Tax Rates
- Top marginal rate for individuals increases from 37% to 39.6% on ordinary income for tax years beginning after December 31, 2021. The tax brackets, meaning the amount of income subject to each rate, is also changed. The top marginal bracket for Married Filing Joint (MFJ) will be applied to taxable income over $509,300 for the 2022 tax year. For comparison, the 2021 highest marginal bracket for MFJ was for taxable income over $628,300.
- Long-term capital gains and qualified dividends for taxpayers with Adjusted Gross Income (AGI) of more than $1 million will be taxed at ordinary rates (39.6%, raised to 43.4% when including the 3.8% net investment surtax). The increased rate is applied only to the extent income exceeds $1 million. Much of the news around this increase in tax rate centered around the unusual plan to have the increase be effective as of the date of “announcement,” rather than an enactment date or other future date. This means the proposed increase could be effective for transactions as early as April 2021, which was when Biden verbalized such tax increase in a speech (as opposed to the release of his Green Book) or the date any legislation was formally introduced.
Other Notable Proposals
While Biden’s Green Book does not include an accelerated decrease of the current estate tax exemption, it does create new rules to capture the built-in capital gain on assets held at death or gifted during the donor’s lifetime. The Administration’s proposals would create situations where taxpayers are forced to recognize “deemed” capital gains even when there is not a traditional sale. These changes are proposed to be in effect for transfers or deaths after December 31, 2021.
Depending on the taxpayer’s overall income in the tax year of the “deemed’ capital gains, those gains could then be subject to the proposed increased capital gains rates.
One of the largest “deemed” sale rules would apply to appreciated property that is either gifted during lifetime or transferred at death. The donor (or decedent) would realize capital gain on the date of the transfer and have an additional filing requirement. The taxpayer’s capital losses from that tax year, as well as loss carry forwards, can be used to offset the capital gain. For a decedent, any capital gains tax paid would be allowed as a deduction on an estate tax return, Form 706, if filed. Discounts that have been traditionally allowed for valuing gifts or inherited property would
not be allowed in determining the fair market value (FMV) for capital gain reporting. The FMV for capital gain reporting then becomes the basis of the asset for the recipient.
There are exclusions of certain transfers from the deemed sale rule. These include transfers to US spouses, transfers of tangible personal property such as household goods, and certain charitable gifts. For owners of a closely-held family business, there are deferral mechanisms for paying the capital gains tax that delay payment until the business is sold or no longer family-owned. Finally, each taxpayer also would have a $1 million exclusion, indexed for inflation, on unrealized capital gains. This exemption is also portable between spouses.
Legislation introduced in the Senate
While Biden’s Green Book is simply policy recommendations, members of Congress have formally introduced legislation that would impact current estate tax laws. One bill, the Sensible Taxation and Equity Promotion Act (STEP Act), has provisions that are very similar to the Biden proposals. The bill focuses on creating a system to tax the unrealized gains in estate assets. Separately, Bernie Sanders has introduced a bill called the 99.5 Percent Act. This bill has the more typical provisions you have seen in this area: a reduction of the estate tax exemption to $3.5 million with a $1 million lifetime gift exemption, increased estate tax rates with a maximum rate of 65% on estates over $1 billion, removal of valuation discounts on certain assets, and limitations on the annual gift tax exclusion, just to name a few. Finally, Elizabeth Warren has introduced the Ultra-Millionaire Tax Act that also seeks to reduce step up basis rules and tax certain unrealized gains. Her bill also includes an annual 2% tax on wealth over $50 million.
As you can see from the proposed changes, the future of our estate tax law has the potential to be dramatically different than the current structure. For taxpayers of higher net worth, there are opportunities available now for lifetime gifts that may not be available in the future, depending on the success of these proposals. There is no “one size fits all” estate plan and these decisions should be thoughtfully made after a detailed analysis. However, now is the time to begin that review if you have not already done so. Your South State Wealth team is ready to help you start the conversation.
