The Tax Cuts and Jobs Act (TCJA) temporarily increased the basic exclusion amount of large estate gifts and reduced federal estate tax rates. The moves were made to help high net worth individuals offset estate taxes at the time of death. But what happens now? How might the new administration change course?
The TCJA doubled the lifetime gift and estate exemption with inflation adjustments in 2018. By 2020, that meant an exemption of $11.58 million, doubled to $23.16 million for couples, with a tax rate of 40% for gifts and inheritance above that amount. These rates currently apply to both the gift tax (transfers of assets during someone’s lifetime) and estate tax (transfers that occur after the asset owner’s death).
It’s a very high threshold that few taxpayers in the U.S. need to worry about. But that fact is artificially reassuring for several reasons.
YOU COULD PASS DOWN MORE THAN YOU REALIZE
First, you may have more applicable assets than you realize. Especially if you’re a business owner. As the Tax Policy Center explains, the assets that trigger these taxes can be both financial including stocks, bonds, and mutual funds, and ‘real’ including homes, land, and other tangible property. Additional triggers include jointly owned assets and life insurance proceeds from policies owned by the decedent.
According to the IRS, “you make a gift if you give property (including money), or the use of or income from property, without expecting to receive something of at least equal value in return. If you sell something at less than its full value or if you make an interest-free or reduced-interest loan, you may be making a gift.”
For small family business owners, these tax rules get murky. What you invested into the business may not be available to help your heirs pay taxes on that value when they inherit or buy the business. Poorly structured sales to family members can even mean you both pay taxes on the same assets, raising the sales price 10-20%. Some closely held businesses and family farms may be able to use special provisions to reduce their gift and estate tax burden or spread payments over time, but fitting within the qualifying parameters takes estate planning savvy.
CHANGES ARE COMING
Second, even with no action from the new administration, the current generous gift and estate tax threshold and rate are set to expire by 2025. It’s unlikely, however, that it lasts that long. The threshold could return to $3.5 million as early as January 1, 2021 (if made retroactive).
President-elect Joe Biden is also considering eliminating the stepped-up basis on estate assets (right now, with stepped-up basis, fair market value of these assets is used, not necessarily what was paid for them originally), hiking up income taxes for households with taxable income over $400,000, and nearly doubling capital gains tax rates for taxpayers with income over $1 million (from 20% to 39.6%).
You may not be ready to pass down personal or business assets to the next generation, but that doesn’t mean you should wait to prepare. If ever there was a time to evaluate your estate plan—and your business structure if you’re a business owner—it’s now. Few plans that made sense over the past four years will still make sense by the end of 2021 without some tweaks. Feel free to contact us with questions.