The big news in the tax world lately has been the President Biden and the Biden administration’s tax proposals found in the “General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals,” or “Green Book,” for short. Steve has already written about how they might affect Real Estate Investors and S Corporation Savings.
In keeping with the current theme I want to discuss the new proposals and how they could affect the future of estate and legacy planning. The proposed rules in this blog post, if passed, would take effect January 1, 2022.
The 2020 Global Wealth Report from Credit Suisse details there are approximately 20.2 million millionaires in the United States; around 6% of the population’s households. Federal estate taxation, in recent times, has really only been an issue for the very wealthy. Mr. Biden’s estate tax hikes would make this an issue for a much greater portion of the population.
Current Estate & Gifting Rules
To start, let’s review how estate tax rules work now.
The Estate Exclusion
The Estate Exclusion is the total amount of your estate that is not subject to tax when you die. The exclusion amount in 2021 is $11,700,000. And married taxpayers double that.
A taxpayer can use this exclusion throughout their lifetime with gifting (the IRS keeps a running total) or pass this amount to their heirs at death, all tax free.
The tax rate on lifetime gifts over the exemption amount is a flat 40 percent. Unsurprisingly, the IRS taxes very few estates as a result.
Step Up Basis
You get to “step up” the basis of inherited or gifted assets to current market value.
Let’s pretend you inherit a house from your favorite relative, Great Aunt Agnes. Agnes purchased the house for $100,000 and it was worth $1,800,000 when she passed away. Your basis gets stepped up to the market value of $1,800,000. The $1,700,000 is completely excluded. You can sell the house immediately and not pay any tax.
And because Agnes’s estate was valued at less than $11,700,000, her estate doesn’t pay any taxes either.
Gifts made while the high exclusion amount is in effect will still apply even if congress later lowers the exclusion amount below $11,700,000. This is good news for people that have been gifting significant assets and have not yet used up their lifetime exclusion.
Biden’s Estate and Gift Tax Proposals
Now let’s contrast the old rules with the Mr. Biden and his Administration’s proposed new rules.
Transfers of Property by Gift or Death Treated as Realization Events
The donor or deceased owner of an appreciated asset would realize a capital gain at the time of the transfer and owe tax. But, there are some exclusions.
First, Mr. Biden’s proposal allows a $1,000,000 estate or gift exclusion. This is transferable to a surviving spouse making the total for a married couple $2,000,000.
Second, it allows US Code § 121 exclusion from sale of principal residence of $250,000 per person or $500,000 for a married couple.
Let’s go back to our Aunt Agnes example…
Agnes purchased her house for $100,000 and it was worth $1,800,000 when she passed away. The total gain is $1,700,000, less the $1,000,000 estate exclusion, less the $250,000 exclusion for selling a primary residency. This leaves you with $450,000 of capital gains that will be taxable, probably between 15%-20%, depending on your total income for the year. And Agnes didn’t leave you any money to pay the taxes.
But what if you intend to keep the house and don’t have the cash to pay the tax…
15-Year Fixed Payment Plan
The proposal allows a 15-year fixed-rate payment plan for the tax on appreciated assets transferred at death for “non-liquid” assets.
The IRS reserves the right to require security at any time when there is reasonable need for security to continue the deferral. The security can be provided from any person, and in any form, deemed acceptable by the IRS.
Gain Realization Events Every 90 Years
Unrealized gain would be recognized by trusts, partnerships, and other non-corporate entities if the property has not been the subject of a recognition event within the prior 90 years. The testing period would start January 1, 1940, making the first possible recognition event December 31, 2030.
This is bad news for wealthy families that have set up dynasty trusts to circumvent gift, estate, and generation skipping transfer (GST) taxes. This is equally bad for partnerships that hold significantly appreciated assets that have never been taxed.
A Few Final Points
The proposed estate tax hikes from Mr. Biden are more aggressive than we’ve seen in recent years, to say the least. And very much less favorable to higher net worth taxpayers.
Estate taxes may no longer pose problems for only very wealthy families. If the proposals go through, many families will be subject to estate and transfer taxes they would otherwise avoid completely under the current rules.
One note for Washington state residents: Remember, too, that Washington state’s estate taxes begin at $2,193,000. (That tax rate starts at 10 percent and eventually ratchets up to 20 percent.)
There is still time for planning, however. Take advantage of the high $11,700,000 before it is gone forever. You can gift assets to would be beneficiaries, or use an appropriately set up trust to remove assets from your estate. The point is, you want to take action now.