Estate Planning Considerations in Light of President Biden's Tax Proposals
New U.S. Presidents often bring changes to federal tax laws. President Biden has presented sweeping proposals to update the current structure of the tax regime. Whether or not you have a large estate, these proposed changes could have an effect on the taxation of your income and assets, either during life or at death.
Thus, now is a good time to review your estate plan to avoid and minimize unnecessary estate taxes and ensure your estate plan still meets your wishes.
Have there been changes in your family, such as marriages, divorces, deaths or births? You will want to make sure your will and trust are still in compliance with federal and Wisconsin state laws. In addition, the COVID-19 pandemic has highlighted the necessity of establishing estate plans for people of all ages, single or married, with or without children.
Income tax proposals; a likely Biden tax law change
President Biden has proposed increasing taxation for taxpayers with high income. For taxpayers with income over $400,000, the rate at which income is taxed in general and for social security purposes may increase, and the rate at which deductions are allowed to decrease income tax liability may decrease. For taxpayers with income over $1 million, the rate at which capital gains and dividends realized are taxed may increase.
If you are a taxpayer with high income, your income, long-term capital gains, and qualified dividends may be taxed at a higher rate and the amount you are able to deduct from your taxable income through “deductions” may decrease. These changes could significantly increase the amount of income tax owed.
Estate and gift tax proposals by President Biden
The President has proposed to reduce the exemption levels of estate and gift taxes. Under current law, in 2021, during lifetime and at death, an individual can pass up to $11.7 million to others without taxation. Biden has proposed to reduce the amount that can pass without taxation to $1 million of lifetime gifts and $3.5 million at death.
Biden has also proposed to eliminate the step-up in tax basis of assets at death. When an asset is obtained, its value becomes its “tax basis.” If an asset is later sold and has significantly appreciated, the seller pays tax on the “capital gains”—the difference between the asset’s tax basis and its appreciated value.
Under current law, upon death, subject to certain exceptions, assets receive a step-up in tax basis to their valuation as of date of death. This means that if the asset is inherited and then sold, there is minimal or no capital gains tax owed. Under Biden’s proposal, there would no longer be a step-up in tax basis and any realized gains -- the difference between the original tax basis and the selling price -- would be taxed when the asset is sold.
Biden’s proposed changes to estate and gift taxes would impact not only those with a taxable estate in the millions of dollars range, but it would also affect those at any income and estate level who are passing appreciated assets to their loved ones at death.
Tax savings opportunities - why reducing your taxable income and estate in the future could be in your best interest
With proposals to increase income, estate, and gift tax liability, now is the best time to start planning how to avoid any unnecessary taxes. There are a number of potential strategies for individuals to take to minimize their liabilities.
Note, no legislation relating to income, estate, or gift tax has been passed.
Individuals and couples are advised to start consulting and planning with their estate planning teams. Individuals and couples are not advised to take any steps to reduce their taxable income or estate without first consulting with professional advisors.
Tax Planning Considerations for 2021
- Recognize gains during lifetime.
Depending on the taxpayer’s tax rates, a taxpayer could sell an asset with a low tax basis, pay the capital gains tax at a lower tax rate now, and gift the cash to the taxpayer’s beneficiaries during life. For example, the taxpayer would pay the capital gains tax on the sale of the asset and give the full cash proceeds to the children instead of giving the children the low tax basis asset upon death, which would require the children to pay capital gains tax when they later sell the asset. This technique would also remove the asset from the taxpayer’s taxable estate at death.
- Continue making annual exclusion gifts and continue medical and education gifts.
The current rate at which an individual can gift to another individual without any tax implications per year is $15,000. Taxpayers can gift this amount to an individual without having to file a gift tax return or pay tax on the gift. Additionally, medical and education gifts paid directly to the institution are free from tax implications. Continuing to make these gifts as well as gifts at or under the current exemption rate would allow a taxpayer to decrease the size of the taxpayer’s estate at death. Note that the Biden tax plan contemplates limiting the annual exclusion to a once-a-year total of $15,000 -- not $15,000 per beneficiary.
- Utilize portability to preserve full exemption amounts or have one spouse use their entire exemption amount.
Upon the death of Spouse 1, any amount of Spouse 1’s unused exemption can be transferred to Spouse 2 to be used upon Spouse 2’s death, thus increasing the amount that can pass without being subject to tax at Spouse 2’s death. Alternatively, Spouse 1 can gift up to the entire current exemption rate during Spouse 1’s lifetime before it expires to decrease the size of Spouse 1’s estate. Spouse 1 will not have any unused exemption to transfer to Spouse 2 if Spouse 1 dies first, but Spouse 1 will have significantly decreased Spouse 1’s estate at death.
Estate Planning Considerations in Wisconsin:
- Charitable Remainder Trusts (CRT)
Taxpayers could consider gifting appreciated property to a Charitable Remainder Trust (CRT) and receive a stream of income for a term of years or for the remainder of their life, which would be considered individual taxable income, until the remainder of the trust passes to a charity. The taxpayer receives an income tax charitable deduction in the year the CRT is created equal to the present value that will pass to charity at the end of the term of the CRT, thus reducing the taxpayer’s taxable income for that year. Additionally, if the CRT sells the asset, the capital gains are not immediately subject to income tax, because charities are exempt from capital gains and income tax liability. The taxpayer could save on income and capital gains tax and decrease the size of the taxpayer’s estate at death.
- Spousal Lifetime Access Trusts (SLAT)
If spouses are interested in making large, permanent gifts to reduce their estate and are comfortable with having limited control and access to such assets, they could consider the use of a Spousal Lifetime Access Trust (SLAT). Spouse 1 can create a SLAT for Spouse 2 which removes the monies from the spouses’ taxable estates but allows Spouse 1, indirectly, and Spouse 2, directly, to benefit from the trust as Spouse 2 and any children can be the discretionary beneficiaries of the SLAT. Both spouses can create a SLAT for the other as long as there are material differences between the SLATs. Spouses can take advantage of the current gift tax exemption by gifting to a SLAT to decrease the size of their estate at death. If the step-up in tax basis is not eliminated, the spouse also has the ability to “swap” assets in the SLAT that have significantly appreciated with assets outside of the SLAT that have not appreciated in order to utilize the step-up in tax basis which is not allowed for assets inside of the SLAT.
- Intentionally Defective Grantor Trust (IDGT)
A taxpayer could create an Intentionally Defective Grantor Trust (IDGT). The taxpayer pays the income tax on the trust, but the trust assets are removed from the taxpayer’s estate. The technique requires the taxpayer to sell assets, e.g. a business, to the IDGT to remove the assets from the taxpayer’s estate at death. Although the taxpayer retains powers that cause the income of the trust to be taxed back to the taxpayer rather than the trust, the taxpayer could save on capital gains tax and decrease the size of the taxpayer’s estate at death.
Estate Planning Attorneys in Wisconsin who can help with your estate tax planning
The estate planning lawyers at Murphy Desmond S.C. have experience helping clients during tax law changes. We are available to review or create an estate plan that benefits your heirs and is in compliance with current laws.
Regardless of your age, estate planning is an important tool to ensure your wishes are met and that the distribution of your assets have minimal tax implications. Contact the estate planning lawyers at Murphy Desmond S.C. in Madison, Appleton, Janesville, and Dodgeville, Wisconsin.
Updated January 20, 2021