Setting the Stage

During his presidential campaign, President Biden proposed reducing the amount an individual can transfer free of estate and gift tax from current limits of $11.7 million down to $3.5 million for individuals and $23.4 million down to $7 million for married couples. Biden also proposed eliminating the step-up in basis, which currently allows heirs to receive assets valued at the date of death. This proposal to eliminate the step-up in basis would result in any unrealized capital gains being subject to tax. Biden has also called for capital gains rates to increase from the current maximum of 20% to 39.6% for taxpayers with income over $1 million. The 39.6% rate is also what Biden proposed the top individual income tax rate be returned to.

What is the likelihood of Biden’s campaign proposals passing in 2021? It’s not entirely clear – but they are unlikely to pass in 2021, as the Biden Administration is primarily concerned with handling the pandemic brought on by Covid-19. Moreover, with Democrats narrowly holding control of the Senate, any tax proposal will require support from all Democrats, which may prove problematic, as moderate Democrats with large Republican bases may be hesitant to favor aggressive tax reform. To garner support from all Democratic Senators, many are predicting that step-up tax basis at death will likely remain the status quo and lifetime estate and gift tax exemptions will only revert to pre-Tax Cuts and Jobs Act levels, which was $5 million for an individual or $10 million for a married couple, adjusted for inflation.

A major concern among individuals seeking to review, revise, or create a new estate plan is whether there will be retroactive tax legislation, aka “claw-back” for gifts made under the high current lifetime estate and gift tax exemption limits. In 2019, the Treasury Department and the Internal Revenue Service issued final regulations confirming that individuals taking advantage of the increased gift and estate tax exemption amounts in effect from 2018 to 2025 (the years the Tax Cuts and Jobs Act is in effect) will not be adversely impacted after 2025 when the exemption amounts are scheduled to sunset to pre-2018 numbers. Nevertheless, with new Congressional makeup and the Biden Administration in power, any new tax law has potential to include claw-back provisions. Experts predict is that if claw-back provisions are included in new tax law, they will only be effective as to gifts made on January 1, 2022 or later.

What Should You Do?

With the uncertainty of new tax law being enacted and the possibility of retroactive claw-back provisions therewith, what can you do right now? Currently individuals can gift up to $15,000 to one person, in any given year, without having to pay any gift tax. For example, a married couple with three children could gift $30,000 to each child every year without having to pay any gift tax. If those children have spouses or have children of their own, the married couple can gift the spouses of their children and their grandchildren $30,000 a year as well. Utilizing your annual gift tax exemption each year is a simple yet effective way to decrease the size of your estate and potentially eliminate any estate tax due at death.

Depending on an individual’s wealth and comfort with gifting, another strategy to effectively lock in the current lifetime estate and gift tax exemptions of $11.7 million per individual is to make gifts beyond the $15,000 annual gift exemption amount. In turn, gifts in excess of $15,000 per person lock in your lifetime estate and gift tax exemptions. For individuals seeking to avoid handing money to children who may not be ready yet, a “Crummey” trust – a trust named after the famous case Crummey v. Commissioner, 397 F.2d 82 (9^th Cir. 1968) – may be a viable option. A Crummey trust contains a right of withdrawal which is designed to give beneficiaries a present interest in the trust and allows the grantor, the creator of the trust, to effectively make completed gifts to loved ones yet ensure the gifts are managed appropriately.  Notably, a Crummey trust allows the grantor to direct what age(s) the beneficiaries will be paid out of the trust; a common distribution scheme is to distribute 1/3 of the trust principal at age 25, 1/2 of the balance at age 30, and the total remaining balance at age 35.

Another option used to lock in current exemption limits is to gift up to the exemption amount to a Spousal Lifetime Access Trust (SLAT). SLATs may be a better option for individuals who are not ready to outright part with their money. SLATs are used to address the possibility of the grantor needing access to the property transferred, as they provide direct access for the grantor’s spouse, thereby allowing indirect access for the grantor through his or her spouse. In addition, SLAT provisions can be drafted to allow the grantor to swap assets to and from the trust, as well as take loans from the trust.  A solid marital relationship is essential for a SLAT, as any gifts to the trust may be unrecoverable in the event of divorce.

For folks who have already locked in every dollar of their lifetime estate and gift tax exemption amounts, there may still be more you can do this year. In 2020, the lifetime estate and gift tax exemption amounts were $11.58 million per individual. In 2021, the exemption amounts increased to $11.7 million. Thus, everyone can lock in an additional $120,000 this year to be passed tax-free.

In conclusion, while it is too early to tell exactly what the Biden Administration will do regarding taxes, given the low probability of retroactive tax law during 2021, clients should not fear implementing new estate planning strategies to maximize the use of their tax exemptions and achieve their estate planning objectives.  Contact a member of our estate planning team today to schedule a consultation to find the right solution for you and your family.