Watching the Sunset – Current Estate Tax Laws vs New Proposals

December 8, 2020

With the presidential election behind us and Joe Biden entering the Oval Office in January, questions and uncertainties still exist regarding his proposed tax package. With the “Blue Wave” of Democratic control over the White House, Senate, and House of Representatives seemingly less likely, major tax reform that was a pillar of Biden’s presidential platform may not be as certain as it was once thought to be. With politics, comes uncertainty, and this time is no different. Adding to the political uncertainty is the fact that current laws are set to expire and “Sunset” at the end of 2025. Therefore, an understanding of current estate tax laws, proposed changes, and some useful tips seem appropriate.

Current Law

Under current law, each person has what is called a “lifetime exemption” 1 of combined gifts they can make during their lifetime and at death which reduces the value of their estate for estate tax purposes. In 2020, the amount is $11,580,000 per person, or $23,160,000 per married couple. In other words, an individual (or married couple) with an estate less than these amounts are not subject to the Federal Estate Tax. It is important to keep in mind that these exemption amounts are set to “Sunset” and drop back down to 2017 levels of $5,000,000 per person ($10,000,000 per married couple), adjusted for inflation, on Jan 1, 2026.

Also, under current laws, assets that are passed at death to an heir and are not considered retirement or qualified assets such as an IRA or 401K, and are not certain types of Irrevocable Trusts, receive a step-up in cost basis which means the date of death value becomes the new cost basis in determining capital gains and taxes owed as the result of future sales.

Joe Biden Tax Proposal

Under Joe Biden’s tax proposal, the first, and major change to estate tax law is a significant reduction in the lifetime exemption. Biden has proposed a lowering of the exemption to what is being referred to as a “historical standard”. Although no specific exemption amount has been proposed, most practitioners believe this to mean a lowering to the $3,500,000 – $5,000,000 range per person (double the amount for married couples). In addition, there has been no specific guidance regarding the tax rate that would be imposed on taxable estates larger than this. Although 40% is the current rate, it is yet to be seen what the future rate would be should tax reform gets passed. Finally, the Biden proposal is designed to eliminate the step-up in cost basis that is available on assets that are not considered retirement/qualified, or certain Irrevocable Trusts. Although the large lifetime exemption available under current law as well as the much lower amounts being proposed by Biden results in most families not being exposed to federal estate tax, the loss of the current step-up in cost basis is a proposed change that will impact many families regardless of the size of their estate.

What Should I Do?

Given the uncertainty in what lies ahead with tax reform, this begs the question “What should I do?” The answer to this question depends on each person’s unique situation, the value of their estate, their goals, and the concerns they have (or not) over the proposed changes. For many, the “Sunset” on December 31, 2025, became an arbitrary expiration date to take more advanced planning steps and avoid repercussions of the automatic lowering of the current lifetime exemption amount under these provisions.

Political “Blue Wave” considerations then caused many to move their planning expiration date up to December 31 of this year, fearing a dramatic lowering of the exemption in 2021. With political uncertainty likely to exist throughout the remainder of the year, and tax policy uncertainty likely to continue throughout 2021 and beyond, it is important to understand how different policy changes may impact your long-term goals and financial plan. The BDF team is here to discuss these considerations with you and to assure you are aware of the options that exist, and in conjunction with your estate planning attorney, help you decide what changes should be made to your current plan if any. Please reach out to your BDF team to discuss this further if you have questions or concerns.

1 the “lifetime exemption” amount is in addition to the “annual exclusion” which allows each person to gift an amount up to $15,000 to any number of individuals

John D. Smith, CFP®, AEP®, is a Wealth Manager at BDF. A member of the Business Owner Team, he is adept at helping business owners integrate their unique business opportunities and risks into their personal wealth management plan, due to his 25+ years of experience. He finds that business owners, in particular, are often so focused on making sure that their business operations are running smoothly, they may overlook their personal financial well-being. John received his Bachelor of Science degree in Financial Counseling and Planning from Purdue University. He is a member of the Chicago Estate Planning Council and the National Association of Estate Planners and Councils and holds the ACCREDITED ESTATE PLANNER® designation.  He is a member of the Financial Planning Association and a member of the University Club of Chicago and active in the club’s Wine Society and Golf Society.

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