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Proposed Estate, Gift and Income Tax Law Changes may Fundamentally Alter the Tax Landscape

Posted: May 18, 2021 |

In the midst of an already tumultuous year, recent proposed changes to the estate, gift and income tax laws are likely to inject further tumult.  These changes are included in several tax bills and White House proposals, namely: “For the 99.5 Percent Act” proposed by Senator Bernie Sanders, the “Sensible Taxation and Equity Promotion Act of 2021” (STEP Act) proposed by Senator Chris Van Hollen and “The American Families Plan” proposed by President Joe Biden.  Below is a summary of the key components from these bills and proposals:

• Increase in Ordinary Income Tax Rate.  Under the Tax Cuts and Jobs Act of 2017, the federal ordinary income tax rate levied on the wealthiest Americans was decreased to 37%.  President Biden’s tax plan would increase the highest ordinary income tax rate back to 39.6%.
• Increase in Capital Gains Tax Rate.  The federal government levies a tax on capital gains, which include gains from the sale of appreciated assets such as real estate and investments.  The maximum federal capital gains tax rate is currently 20% (in addition to a 3.8% investment surtax and in addition to a California tax rate of 13.3%).  President Biden proposes to increase the maximum federal capital gains tax rate to be equal to the ordinary income tax rate of 39.6%.  When combined with the investment surtax and California taxes, that would result in an overall tax rate of 56.7% on capital gains.
• Elimination of 1031 Exchange.  A 1031 exchange allows a real property owner to sell the owner’s real property and to use the sale proceeds to purchase a replacement property without having to pay any income taxes on the sale.  President Biden’s proposal would eliminate the tax-free 1031 exchange for sales of real property where the gain from the sale exceeds $500,000.
• Elimination of Step Up in Income Tax Basis at Death.  Under current law, when an individual dies, the income tax basis of the inherited property receives an adjustment to be equal to the value of such assets as of the date of death.  With appreciated assets, this results in a step up in the income tax basis, which minimizes the income taxes that the recipient pays when the asset is subsequently sold.  President Biden proposes to eliminate the step up in income tax basis at death, which will result in a significant increase in income taxes the recipients will pay when the inherited assets are sold.
• Lifetime Gifts and Death Treated as Tax Recognition Events.  Another, more draconian, proposal would treat a gift of appreciated property and an individual’s death both as tax recognition events as if the recipient had sold the asset on the date of the gift or at death.  There would be an exclusion of $1,000,000 of gain at death and an exclusion of $100,000 for gifts made during life, which if used, would reduce the $1,000,000 exclusion for transfers made at death.  Although the proposal would allow the recipients of the inherited assets to pay the income tax over an extended period of time, the provision would likely force many families with gains greater than the exclusion amounts to sell the inherited assets in order to finance the tax bill.
• Estate Tax Exemption Decrease.  The estate tax exemption currently sits at $11,700,000 per person ($23,400,000 for a married couple).  The proposal would decrease the estate tax exemption to $3,500,000 per person ($7,000,000 for a married couple).  This change would greatly expand the number of families whose estates will pay estate taxes after their deaths. 
• Lifetime Gift Tax Exemption Decrease.  The proposal would decrease the lifetime gift tax exemption to $1,000,000 per person ($2,000,000 for a married couple).  The lifetime gift tax exemption is currently equal to the estate tax exemption of $11,700,000 per person ($23,400,000 for a married couple).  This change would significantly diminish the ability of parents to pass wealth down to their children during life.
• Curtailment of Annual Exclusion Gifts.  Currently, an individual may make gifts valued at up to $15,000 to as many individuals as she chooses per year without using any of her lifetime gift tax exemption.  The proposal would cap the annual exclusion gift to $10,000 per person and limit the total number of such gifts to two per year (in other words, restricting a total of $20,000 of gifts per year). 
• Limit the Applicability of the Generation Skipping Transfer Tax Exemption.  Currently there is a Generation Skipping Transfer (GST) tax exemption equal to the estate tax exemption ($11,700,000 per person).  This exemption allows grandparents to set up trusts for the benefit of their children during the children’s lives and then to pass those assets down to grandchildren without incurring an additional GST tax liability.  The proposal would only protect those inherited assets for a maximum of 50 years, which would restrict the use of so-called Dynasty trusts.
• Changes to Grantor Trusts.  Attorneys have used grantor trusts in various forms (e.g., intentionally defective grantor trusts (IDGTs), irrevocable life insurance trusts (ILITs), and grantor retained annuity trusts (GRATs)) as a powerful estate planning tool.  The proposal would treat the distribution of appreciated assets from the grantor trust as a tax recognition event, triggering the imposition of an income tax.

There is much uncertainty as to which, if any, of these proposals are likely to pass and we will have greater clarity as the year progresses.  Nevertheless, if you believe that the value or composition of your assets warrants some further analysis in light of these proposals, we recommend you call our office to schedule an appointment. 

 

This blog is not meant to provide specific legal advice. For advice specific to you and your tax situation, please contact any of the attorneys in our Estate Planning Practice Group who are ready to assist you.