The release of the Treasury’s “Green Book” on May 28th offers insight into the Biden Administration’s proposals for changes to income and estate taxes. Here we focus on the estate tax proposals, as specified in the Green Book and referred to in other Administration communications.
Since the start of his campaign, President Biden has clearly stated his intention to change the estate tax system (which Parkside previously discussed in September 2020). The proposed estate tax changes are meant to eliminate the intergenerational wealth transfer tools that have traditionally benefitted wealthier taxpayers.
The proposals include three major estate tax provisions:
- The repeal of the “step up in basis” at death,
- recognition of gain at the time of death or transfer, and
- a reduction to the estate and gift tax exclusion amounts.
Repeal of the Step Up in Basis at Death
The elimination of stepped up basis is one of the Biden Administration’s priorities.
Under current law, a decedent’s estate is valued at Fair Market Value (FMV) net of loans, mortgages, and administrative expenses, on his or her date of death, regardless of the decedent’s tax basis. Inherited assets are transferred to beneficiaries with a tax basis “stepped up” to the FMV at the time of the decedent’s death. The result is that appreciation in these assets is never subject to capital gain tax.
Under the proposal, assets would no longer receive a step up in basis at death.
Automatic Recognition of Gain at the Time of Death or Transfer
The Green Book proposal contains some notable surprises, including taxing the appreciation of most assets at the time of death, with an exclusion for transfers to a spouse.
The proposal provides for an exclusion from tax for up to $1,000,000 of gain, and up to $250,000 of gain for a personal residence, per decedent, on property transferred by gift or held at death. Current losses and previous losses carried forward on the decedent’s tax returns may be applied to determine the net taxable gain in the estate.
It further proposes that gifts and other transfers during one’s lifetime also trigger recognition of gain. Transfers to revocable trusts would be excluded from automatic gain recognition.
Also notable is that the current exclusion from tax for capital gain on small business stock (Section 1202) would remain.
Finally, starting in 2030, the proposal calls for taxing appreciation in trusts and partnerships when appreciation has not been recognized in the previous 90 years.
There are certain accommodations for family-owned and operated businesses and illiquid assets, which we will not detail here.
Automatic Recognition of Gain on Charitable Donations
The proposal includes taxing the appreciation of charitable gifts at the time the gift is made. This change would negate the tax benefit of transferring appreciated assets to charitable organizations, including donor-advised funds.
Reduction of the Estate and Gift Tax Exclusion Amounts
Not specifically mentioned in the Green Book, but a plank of Biden’s campaign and endorsed in communications since the election, is a reduction in the amount excluded from estate and lifetime gift taxes. The exclusion is currently $11.7 million per person. Biden has referred to a reduction to “historic” levels, generally expected to be close to the $5.45 million level in place before the 2017 Tax Cuts and Jobs Act changes.
Under current law the exclusion amount is scheduled to revert to the $5.45 million level in 2026, adjusted for inflation. It is expected that Biden would look to accelerate the timing of the reduction to 2022.
Elimination of Valuation Discounts
Valuation discounts are sometimes used by taxpayers to reduce the value of gifts made from or assets held by an estate, such as those held in Family Limited Partnerships. These discounts are expected to be eliminated.
Estate Tax Rate Increase
The current top tax rate on estate assets above the exclusion amount is 40%. The expected proposal would increase the top tax rate to 45%.
Per the Green Book proposal, estate tax changes would become effective after December 31, 2021.
What to do?
Although the elimination of a stepped up basis has long been anticipated, the recognition and taxation of appreciation at the time of death or gift is a surprise to many. Some professionals think this is unlikely to gain enough legislative support for passage.
In many cases, enactment of the proposals would render much of current estate planning strategies ineffective, or even detrimental. Until there is more certainty surrounding the changes, it will be difficult for estate planners to help clients execute changes to their plans.
We recognize that “proposed” is a long way from “enacted.” Still, there is much that can be done in anticipation of the changes, for example, considering a gift and transfer strategy now, that can be executed quickly when there is more certainty of the changes.
One thing is certain – estate attorneys will be swamped in the last few months of 2021 if changes are enacted. The most important advice we offer is for you to schedule time with your estate attorney now, to plan for possible and likely changes and to allow sufficient time to revise your strategy.
Please contact us to discuss these proposed estate tax changes and your unique situation. Of course, estate tax planning is only one piece of the strategic tax planning services that Parkside Advisors provides.