Emerging Tax Proposals Narrow the Window for Estate Planning, Emphasize Need for Early Action

As proposals to lower the estate and gift tax exemption take shape from the White House, Senator Sanders, and others, this First Alert explains how these proposals will likely also eliminate or curtail the most popular strategies for using one’s remaining exemption. Despite uncertainty, early action is the key to securing efficient use of the current higher exemption amounts. Many of these proposals, if enacted, would be effective either as of January 1, 2022, or, in some cases, as early as the date of enactment.

Lowering Exemptions and Possible Changes to Annual Gift Exclusion

Under both President Biden’s tax proposal and Senator Sanders’ “For the 99.5% Act,” the estate tax exemption would be reduced to $3.5 million per person, and the gift tax exemption would be reduced to $1 million per person. These exemptions would be far lower than the current exemptions of $11.7 million for both the estate and gift tax and lower even than the $5 million exemption that will return in 2026 if no changes are made. While the White House proposes raising the top estate tax rate to 45%, Senator Sanders would raise the rate even higher for larger estates. For example, estates ranging between $10 million and $50 million would be taxed at 50%, and estates greater than $1 billion would be taxed at 65%. Additionally, by lowering the gift tax exemption to $1 million, both plans would significantly reduce opportunities for lifetime planning without incurring gift tax liability.

Another significant feature of Senator Sanders’ plan involves changes to the annual gift exclusion. Whereas currently a donor can gift up to $15,000 to each donee, Senator Sanders’ plan would reduce this number to $10,000, and, moreover, would limit the total amount of annual gift tax exclusion to $20,000 per donor, per year.

The Step-Up in Basis and Capital Gains

The White House proposal also would eliminate the step-up in basis for assets transferred at death. Another Democratic proposal, the Sensible Taxation and Equity Promotion (STEP) Act, would allow for basis step-up for the first $1 million in unrealized gains plus an additional $500,000 for a personal residence passed at death. All other assets would not receive a step-up in basis. Under this plan, taxpayers would have 15 years to pay the tax on illiquid assets such as businesses and farms. Each of these proposals would impose significant additional capital gains liability on beneficiaries. This is even more pressing in light of a proposal from the White House to eliminate the preferential 20% tax on long-term capital gains and tax all such gains as ordinary income.

Targeting Wealth Transfer Strategies

Beyond merely lowering the exemption and raising the rate of tax on estates and gifts, Senator Sanders’ proposal includes several major changes that directly target some of the most effective strategies for tax efficient wealth transfer, including the following changes:

1. The plan would reimpose Generation Skipping Transfer (GST) taxes on trusts lasting longer than 50 years, even where GST exemption has been applied;
2. The plan would require grantor retained annuity trusts (GRATs) to last a minimum of 10 years, significantly increasing the risk and reducing the utility of these trusts;
3. The plan also would reduce or eliminate the ability of non-business entities (e.g., a family limited partnership that only holds securities) to take valuation discounts for minority ownership; and
4. Finally, and perhaps most significantly, the plan would make irrevocable gift trusts far less tax efficient by eliminating the use of the so-called “grantor trust” rules for these types of trusts. This change would require the beneficiaries (in most cases), rather than the donor, to bear the income taxes of the trust’s assets.

Next Steps

Those aiming to use their full $11.7 million exemption should consider acting now, despite uncertainty about which proposals may ultimately become law. Most of the current proposals involve lowering the estate and gift tax exemptions to their lowest point in more than a decade; if enacted, many of the preferred strategies for passing wealth may be unavailable either later this year or by the start of 2022. Every family is unique, and effective planning for any situation can take months, so the time to start preparing is now.

At Calfee, our expertise in both planning and administering wealth transfer strategies can help you take advantage of a historic, but potentially closing, window of opportunity.