The Treasury Department released its 114 page “green book” two weeks ago. It included its proposals on estate taxes. Back on April 21st, our blog “Biden’s Tax Plan-Are you Ready?” focused primarily on corporate taxes. Today’s blog will focus on estate taxes. We’ll first focus on proposals, discuss the likelihood of what might become law, and then look at some strategies we’ve been discussing with DWM clients.
President Biden’s main objective is to tax the wealthiest Americans to fund his plans for infrastructure, climate change and other programs. Here are the key elements:
- Reduce the lifetime exemption. The current lifetime exemption is $11.7 million per person ($23.4 million for a couple). President Biden is looking to reduce the exemption to $5 million or perhaps $3 million per person.
- Increase the tax rate. Biden’s proposal would likely also increase the tax rate from 40% to 50%.
- Reduce the Step Up in Basis. Currently most assets owned by the deceased are “stepped up in value” as of the date of death when the taxpayer dies. This includes capital gains items such investment securities, business interests as well as homes and real estate investments. Items considered Income in respect of a decedent (“IRD”) are not stepped up in basis and include items such as IRAs, annuities, uncollected salaries and accrued interest and dividends. The Biden proposal would raise the top capital gains tax rate from 23.8% to 43.4% and only exempt $1 million of capital gains at death. For example, an estate that had a value in excess of basis by $3,000,000 at the date of death would be assumed to be sold at death and capital taxes of $2,000,000 times 43.4% or $868,000 which either the estate or the beneficiaries would have to pay.
No one knows if any changes will ultimately be made to the estate tax rules, particularly with a divided Congress. Further, no one knows what changes in the estate tax rules might be made in in the future. So, some suggest that you simply wait and see what happens.
We don’t look at it that way. There are many estate planning techniques which can help in the future, regardless of the estate tax rules in effect at the time of death. Principally, these are designed to transfer assets and freeze or eliminate values that might be included in an estate. The impact of many of these actions is based on time-so action taken now may make a big difference in the future. Freezing $1 million today which grows for 30 years at 7%, for example, to $7.6 million, produces an estate reduction of $6.6 million. In addition, if desired, the current owner may continue to pay income taxes on the earnings over that period, which further reduces the estate.
There are circumstances where planning can be made now that has overall benefits that will help the family regardless of changes now or in the future regarding estates tax rules. Here are some that our clients, their estate attorneys, their CPAs and we at DWM have been discussing so far this year:
- Irrevocable Trusts. You gift assets today using a portion of your lifetime estate exemption. You no longer control these assets, but the growth on those assets over time is excluded from your estate tax return.
- Donor Advised Fund. You make contributions now, while you are working or when you sell a business to reduce income taxes. The funds can continue to grow over time and you determine what charities get the money during your lifetime or at death. (You don’t get a second deduction when the charity gets the money). In addition, the contributions can be made with appreciated securities, which eliminates the capital gain taxes you would have paid when selling those.
- Gifting or Selling Stock in the Family Business to Children. This can reduce current income taxes, reduce taxes at the time of sale of the business, and reduce estate taxes in the future. It can also serve as a catalyst to help the adult children learn more about finances and investments. Note that full-time students age 23 and younger must provide half their support or their share of the company income will not be taxed at their tax bracket but at their parent(s)’ tax bracket. Furthermore, a shareholder agreement should be used to eliminate sales or transfers by the new shareholder, as well as provide a mechanism to repurchase the shares if necessary.
- Realizing a certain amount of capital gains in 2021. This likely ensures the current tax rate on capital gains for a portion of the portfolio. Furthermore, this exercise may allow for rebalancing of the investment portfolio to provide a more appropriate asset allocation for their heirs.
- Establishing a Family Partnership, LLC. Assets, particularly highly appreciating assets, can be placed into an LLC. The ownership is split between a general partner (the contributor of the assets) and limited partners. Limited partner units can be given or sold to children. This again freezes assets like an irrevocable trust but allows for a larger amount of control.
The objective of all of these strategies is to reduce estate and or income taxes. There is some loss of control on each of these options. Therefore, you and your advisors must analyze the potential benefits and costs and proceed accordingly. Everyone’s circumstances are different and determining the best strategy or strategies requires knowledge and experiences in these areas and a deep understanding of the family and its goals. Accordingly, it’s an important topic that DWM loves to use to add value to clients. We’re here to discuss estate taxes anytime.