Covid 19 – It is the Time to Review and Adjust One’s Estate Plan

With the Biden Administration installed in the White House, and Democratic control established in both houses of Congress, it is much more likely that President Biden will propose significant Estate Tax reform. This article focuses on potential Biden Administration changes to laws governing: (a) the Estate Tax personal exemption and (b) the step-up in tax basis upon certain assets passing through inheritance at one’s death.

With respect to the Estate Tax personal exemption, the Tax Cuts and Jobs Act of 2017 (the “2017 TCJA”), doubled the lifetime gift, estate and generation-skipping tax exemptions to $11.18 million from $5.6 million. Adjusting for inflation, the current exemption this year is $11.7 million — the highest it has ever been. This permits each person to give away up to $11,700,000 through gifts during one’s lifetime and/or distributions upon one’s death without incurring any Federal Estate Tax. However, the portion of the 2017 TCJA dealing with the personal Estate Tax exemption is due to expire at the end of 2025. Unless Congress changes the laws prior to that “sunset” date, the personal Estate Tax exemption will decrease from $11,700,000 to $5,000,000 per person.

Accordingly, at present, each person currently possesses what might be called a “bonus” exemption of $6,700,000 (calculated by taking the current Estate Tax exemption of $11,700,000 and subtracting $5,000,000, which is what the Estate Tax exemption is anticipated to be after the 2017 TCJA expires in 2026). For many, it may be advisible to use some or all of this “bonus exemption” that one may have to the fullest extent permitted by law because if not used, a bonus exemption becomes null and void. Moreover, the IRS has taken the position and stated that if a taxpayer uses his or her bonus exemption in 2021 there will be no attempt by the IRS to pursue recovery of any distributions made by such usage if and when in the future the Estate Tax exemption is decreased by future laws.

With the goal of reducing or eliminating a client’s Estate Tax liability, there are several estate planning techniques that can be utilized as part of one’s estate plan. Under current Federal Estate Tax and Gift Tax laws, each person has an annual gift tax exclusion which allows a person to gift up to $15,000 per year to any other person without using any of one’s Estate Tax exemption. Also, one may gift up to five (5) years of the $15,000 annual gift tax exclusion ($75,000 total and $150,000 if a married couple) to create a special account called a 529 Account to fund the education of one’s child or grandchild. Moreover, one can pay certain college and medical expenses directly to a third party and get money out of one’s estate without having to utilize any of one’s Estate Tax exemption. Finally, for high-net-worth individuals, it is often recommended that during their lifetime they make large gifts either out right or into trusts in order to use up a portion of one’s Estate Tax exemption while it is at the current 2021 level.

In particular, President Biden has proposed changes to the calculation of basis for assets received as a result of the death of another taxpayer. Tax basis is, generally speaking, the price one pays for the acquisition of an asset, along with capital improvements, if any. When an asset is sold, the difference between the sale price and the tax basis [adjusted] is subject to capital gains tax. Under present tax law, when all of the assets are included in the estate of a decedent (excluding retirement accounts and annuities which receive a tax basis equal to their fair market value), such assets are given a new stepped-up tax basis equal to the then current date of death fair market value of the assets. Therefore, this means that if one purchased IBM stock at $10.00 per share and on the date of one’s death, the price of a share of IBM stock is $90.00 a share, the tax basis of the IBM stock would be stepped-up to $90.00 per share. When the shares of stock are distributed to the beneficiary of the decedent’s estate, the beneficiary would receive the stock having a tax basis of $90.00 per share. Moreover, when such beneficiary sells the IBM stock, he or she will utilize the $90.00 per share stepped up tax basis and will only pay capital gains tax to the extent that the sale proceeds received for that IBM stock exceeds $90.00 per share.

President Biden campaigned on a proposal to change the law and remove the concept of a step-up in tax basis (please see: https://joebiden.com/healthcare/?mod=article_inline). Therefore, in the above example, the beneficiary would inherit the IBM stock having a tax basis of $10.00 per share, which was the decedent’s tax basis in the stock, in lieu of the stepped up tax basis of $90.00 per share under current Estate Tax law. This is significant for when such beneficiary sells the IBM stock, he or she will use the tax basis of $10.00 per share and then will pay capital gains tax to the extent that the sale proceeds received for the IBM stock exceeds $10.00 per share. Therefore, the beneficiary would pay capital gains tax on the $80.00 gain in the IBM stock for the time the decedent owned the stock and also, pay any additional capital gains tax on any applicable gain in the stock since the date of death.

One strategy to achieve a step-up in basis is to sell assets to a Private Foundation or to a Trust. An individual can establish a Private Foundation as the donor and can establish and implement a charitable gifting program. An individual could also establish a Trust through which any trust income and the trust principal can be distributed as donor designates under the applicable Trust instrument. At the closing of such asset sales, the Private Foundation or Trust would obtain a tax basis equal to the amount paid for the applicable asset(s). Also, any applicable appreciation of the asset(s) sold and purchased would be reported by the Private Foundation and the Trust and such appreciation would be outside of the donor’s estate. However, achieving this step-up in basis by the Private Foundation or Trust must be balanced with the fact that the consideration paid to donor / seller will be considered to be part of donor’s estate.

Accordingly, with the current COVID-19 Pandemic still in full swing and a COVID-19 Relief financial package likely to occupy much of President Biden’s time and Congress’s time for the next few months until most of the country is vaccinated and on its way to recovery, now is the time to seize the moment and meet with one of the firm’s estate planning attorneys and evaluate and update your estate planning documents. If you do not have an estate plan, it is time to have estate planning documents drafted to reduce or minimize your potential Estate Tax exposure before the Estate Tax and Gift Tax laws are replaced with lower limits and loss of step-up in basis.

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This alert should not be construed as legal advice or a legal opinion on any specific facts or circumstances. This alert is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The contents are intended for general informational purposes only, and you are urged to consult your attorney concerning any particular situation and any specific legal question you may have. We are working diligently to remain well informed and up to date on information and advisements as they become available. As such, please reach out to us if you need help addressing any of the issues discussed in this alert, or any other issues or concerns you may have relating to your business. We are ready to help guide you through these challenging times.