How 2021 Estate Tax Legislation in Congress May Impact Your Estate Plan
Since the moment President Biden was declared the winner of the 2020 election, attorneys, tax planners, and financial professionals have speculated about how the new administration might change the tax landscape, particularly with regard to estate tax planning. From the campaign through the early months of the administration, a number of proposals for tax changes have been discussed, including reduction of the 2021 estate tax exemption. A reduction to that unified exemption would reduce the amount a person or couple could give during life or leave to others upon death before incurring federal gift or estate tax.
Another proposal was the elimination of the “step up” in basis on the death of an asset’s owner, allowing heirs or beneficiaries to avoid being taxed on the capital gains that accrued during the late owner’s lifetime. Also considered was the idea of taxing capital gains on an asset at the owner’s death, regardless of whether the person inheriting the asset sold it and realized the gain. The effect of any of these changes, alone or in combination with others, would have had a significant impact on estate planning.
None have materialized into law thus far, and to the surprise of many, the Build Back Better Act that recently passed in the House of Representatives does not contain any provisions eliminating the step up in basis or reducing the unified gift and estate tax exemption amount. That said, individuals and couples with high net worth should still be on alert for potential impact on their estate planning.
Will there be 2021 Federal Estate Tax Exemption Changes?
Under current federal estate tax law, the federal estate and gift tax exemption is $11.7 million. That means that an individual can give away $11.7 million during life and at death without federal transfer tax being applied. A married couple can give $23.4 million, and if one spouse doesn’t use up their entire amount, the exclusion is “portable” to the surviving spouse.
The amount of the exemption has gone up and down over time, due both to adjustments for inflation and legislative changes. For example, the Tax Cuts and Jobs Act of 2017 (TCJA) increased the federal estate and gift tax exclusion amount from $5.49 million to $11.18 million. Even if the current administration does not reduce the amount of the exemption, it will decrease in a few years. That is because the TCJA included a “sunset” provision. After December 31, 2025, the temporary doubling of the exemption comes to an end.
It is good news for those with significant assets that the Build Back Better Act did not accelerate the sunset of the increased exclusion amount. That said, nothing in the Act will do anything to delay the sunset, either. Individuals and couples with high net worth should not expect the current high exemption amount to stick around forever, and should think about how the December 31, 2025 sunset of the higher amount will affect their current estate plan. Changes may be in order to reduce the size of their future taxable estate.
How Does the Build Back Better Act Affect Income Taxation of Estates and Trusts?
While many provisions about which planners were concerned did not make it into the Build Back Better Act, the news isn’t all good. The Act contains provisions that could impose new income tax surcharges on estates as well as irrevocable trusts. The so-called “Millionaire Income Tax Surcharge” would also apply to individuals.
For individuals, the Act would apply a surtax of 5% on income over $10 million, with an additional 3% surtax on income in excess of $25 million. However, the surtax kicks in for income of estates and trusts at a much lower threshold. The 5% surtax on estate and trust income is applied for income of $200,000 and above, with the extra 3% surtax imposed on trust or estate income of $500,000 or more. Individuals who have funded irrevocable trusts should contact their estate planner or financial advisor to learn how the Act, if passed, could affect them.
In its current form, the Build Back Better Act does not contain any of the more extreme tax proposals that were being discussed earlier in 2021. However, it is not out of the question that legislation that was previously proposed and drafted could be slipped into a bill (or back into a bill) shortly before voting on the bill takes place. Such an outcome seems unlikely for the Build Back Better Act, but it is not impossible.