Competing tax proposals could seriously impact your estate plan

But First: An Estate Tax Overview

Estate taxation is triggered by the transfer of wealth (above certain levels) from a deceased person to their beneficiaries. There is a federal estate tax, and some states (not including Arizona) exact their own estate tax. The federal estate tax rate depends on the size of the estate, with the top rate currently set at 40%.

The tax code includes two provisions that, for most Americans, significantly reduce estate tax liability:

• First, there is an estate tax exemption of up to $11.7 million per person ($23.4 million for a married couple), meaning that estates valued below those levels would be exempt from the tax, and the estate’s assets would convey to beneficiaries at their full value.

• Second, the annual exclusion allows the gifting of up to $15,000 per giver, per recipient, each year without reducing the lifetime gift exemption of $11.7 million. If a husband and wife have three children and seven grandchildren, each spouse can make 10 gifts of $15,000 to each of their kids and grandkids in a single year, and the total gifts of $300,000 do not reduce the couple’s lifetime exemption amounts.

And Second: Capital Gains Tax

Federal capital gain taxes are assessed on the increased value of an asset when it is sold. For example, if a share of stock that was purchased for $10 is ultimately sold for $50, the resulting $40 capital gain is subject to tax, at capital gain rates, in the year in which the stock is sold.

Under the current tax code, appreciable assets are forgiven their capital gains when they are conveyed after the owner’s death. Using our stock example above, if a beneficiary receives the stock at its appreciated value of $50, the stock is not taxed, and the beneficiary owns the stock with a starting basis value of $50 (with $0 of appreciation), rather than at a starting basis of $10 (with $40 of appreciation). This is called having a “step-up in basis” and is an important tool for realizing tax savings in your estate planning.

However, this step-up in tax basis is at risk of being removed from the tax code under both the Biden and Sanders proposals.

Sen. Sanders: For the 99.5 Percent Act

Senator Sanders’ estate tax proposal is included in his “For the 99.5 Percent Act,” which would reduce the estate tax exemption to $3.5 million per individual (from the current $11.7 million). The Sanders plan would also:

• remove the step-up in basis that now applies to upon-death transfers of appreciable property,

• impose higher tax brackets for “larger” estates – a 40% to 65% tax rate for estates worth over $3.5 million, and

• abolish the “unified” tax credit, which presently allows an individual to make up to $11.7 million of taxable gifts regardless of their timing as life-time or testamentary transfers, by reducing the exemption amount of life-time transfers to $1 million.

For a closer look at the Sanders plan, see Forbes’ April 2 article, “For The 99.5 Percent Act - What It Is, What It Does And What To Do About It.”

President Biden: American Families Plan

The many proposals contained in President Biden’s “American Families Plan” also include changes to the estate tax. Perhaps the most striking difference between the Sanders and Biden plans is that the President would keep the lifetime estate tax exemption amount at $11.7 million per individual.

Like the Sanders plan, the Biden plan would eliminate the step-up in basis tool for unrealized capital gains worth over $1 million. Also, the President favors taxing capital gains at ordinary income tax rates – with a top marginal rate of 40% -- compared to 23.8% today.

See another Forbes article, “Analyzing the Tax Provisions of Biden’s American Families Plan” (May 11, 2021).

Looking Ahead

Whether Congress ultimately goes for President Biden’s plan or Sen. Sanders’ more dramatic proposals, and even if Senate Republicans are able to rein in the scope of the changes, significant alterations in the estate plans of literally millions of Americans are all but certain for 2022.

Even if the Biden plan prevails, preserving the lifetime estate tax exemption amounts, many estates might benefit from making 1031 exchanges or gifts to charitable remainder trusts in 2021, to better prepare for changes to capital gains treatment in 2022.

However, every situation is different, and consulting with your estate planning attorney can determine what is best for you and your family in the wake of what promises to be a major shift in estate planning in the coming year.