We are now less than one week away from Election Day 2020. In fact millions of people have already cast their ballots in early voting and through the mail. There are a lot of major issues on the ballot this November, but one issue, that perhaps receives short shrift, but can have a huge effect on many people’s lives, is the potential for a change to the federal estate tax regime. In fact no matter whom is elected president, it is likely we will see some change in the estate tax law. This article will set out the potential changes based on a Republican win and a win by the Democrats.
About eleven months into his first year in office, in December 2017, President Donald J. Trump signed into law the Tax Cuts and Jobs Act (the “TCJA”). Among other provisions, the TCJA doubled the federal estate and gift tax exemption amount from $5 million to $10 million, adjusted for inflation. For example, for 2020 the federal estate and gift tax exemption is $11,580,000. However, the doubling of the federal estate and gift tax exemption is scheduled to sunset on December 31, 2025, and revert back to the previous $5 million exemption, adjusted for inflation. If President Trump wins the election one item on his agenda for the next four years will be to make the doubling of the estate tax exemption permanent.
Vice-President Biden has stated that he plans to reduce the estate tax exemption back to previous levels. No one knows exactly what this means. When Vice-President Biden was Vice-President under President Barack Obama the estate tax exemption was set a $5 million adjusted for inflation. Some speculate Vice-President Biden’s plan would be to roll back the estate tax exemption to the $5 million adjusted for inflation and essentially do away with the doubling of the exemption under the TCJA. Others speculate that Vice-President Biden could seek to reduce the exemption to as low as $3.5 million, which was the level set by President George W. Bush’s tax cuts.
Vice-President Biden’s second plan for a change in the estate tax law would have a much further reach and a significant impact on almost every estate, from the ultra-high net worth estate to the modest estate. Vice-President Biden has indicated that he would do away with the basis step-up at death. This begs the question, what is the basis step-up at death?
When a property is purchased the purchaser has a tax basis in the property equal to the purchase price. Upon the sale of the property, a capital gain tax is assessed on the difference between the basis in the property and the purchase price. For example, if you purchased a property for $100,000 and the property is now worth $500,000, you would owe capital gains tax on the $400,000 difference between the sales price ($500,000) and your basis ($100,000). The capital gains rates are approximately 15-20% for federal and 4% to 8.82% for New York state (New York treats capital gains as ordinary income). The percentage you would pay in capital gains tax is dependent upon your income.
If the property is transferred to another party as a gift, the other party has the same basis in the property as the person who made the gift, called a “transferred basis”. However, currently, upon your death, most assets in your estate receive a “basis step-up” to their fair market value on the date of your death. Using the example above, instead of your heirs having a basis of $100,000 (your transferred basis) in the property being sold, they would now have a basis of $500,000 (the “stepped-up basis”). If your heirs decided to sell the property immediately for $500,000, no capital gains tax would be due. Vice-President Biden has expressed that he wants to do away with the basis step-up rule. This means that upon death your heirs would inherit your basis in the property along with the property. This will lead to potentially large capital gains taxes assessed on sales of property have someone’s death.
At current exemption levels the estate tax effects very few estates. So, changes to the estate tax law, either increasing or decreasing the exemption, to a certain degree, only benefit and only burden a small number of people. However, even the most modest estate, if the decedent owned any stock or real estate or similar assets, benefits from the step-up in basis. Houses are a great example of this. In many estates the primary asset is the decedent’s home, which was typically purchased many, many years ago and has a basis close to zero. If the decedent’s heirs did not receive a basis step-up they would likely owe a capital gain tax on almost the full purchase price. Stock is another great example. Many people have stock they invested in many years ago or received as part of their compensation. Their basis in the stock may be quite low compared to its current value. Currently, upon death if the heirs sell the stock immediately, no capital gains tax should be due because of the basis step-up. However, without the basis step-up a capital gains tax will be due based on the difference between the sales price and the decedent’s basis, likely low basis. Basically under Vice-President Biden’s plan instead of a stepped-up basis, heirs will receive a transferred basis.
Do I Need to Update My Estate Plan Based on Election Results?
Historically, we have only seen major changes to the estate tax laws when one party controls the House of Representatives, the Senate and the White House. So, if Vice-President Biden becomes President Biden, he will need to see the Democrats overtake Congress in order to have his tax plan put into effect. If Vice-President Biden does win and the Democrats retain their majority in the House of Representatives and overtake the Republican majority in the Senate, then there are two types of individuals who should immediately consider estate tax planning.
First, if you will have an estate over $3.5 million, you should consider using the current $11.58 exemption now, while it is still available. If your estate is worth exactly $11.58 million and the estate tax exemption is reduced to $3.5 million, your estate would owe an estate tax of approximately $3,232,000. Additionally, there are various estate tax planning devices that you could take advantage of now, with the much higher estate tax exemption, that would allow you to transfer much more than the $11.58 million exemption estate tax free. We cannot predict what the estate tax laws will be in the future, so this may be a final chance to take advantage of such a large estate tax exemption amount.
Second, if you have an estate that was not going to be taxable under the current estate tax exemption of $11.58 million and you have updated your estate plan to take advantage of income tax planning rather than estate tax planning, you should revisit your estate plan to make sure that your estate will not be subject to an estate tax, if the estate tax laws change as contemplated. Please remember, the estate tax rate is 40% and the capital gains rate is up to 20%, so it is always better to avoid the estate tax rather than the capital gains tax, if both taxes cannot be avoided.
Also, please note, as per my article entitled, “No Need to Fear a Federal Claw Back”, on November 26, 2019, the Treasury Department and the IRS issued final regulations under IR-2019-189, which basically state that if a taxpayer were to use the full estate and gift tax exemption amount prior to the sunset, there will be no claw back. Therefore, the general thinking is that based on this regulation, even if the tax laws were to change under a Biden presidency, anyone who has previously used the larger estate tax credit should be safe from those transferred assets being brought back into their estate for federal estate tax purposes.
No matter who wins the 2020 election it is likely that we will see some change to the estate tax laws over the next four years. The coronavirus pandemic has been costly, and the estate tax is a prime place for politicians to raise revenue, without losing too much political capital, as the estate tax already effects so few estates. If your estate is at or above $3.5 million it is a good idea for you to review your current estate tax planning, prior to the estate tax law changing and potentially increasing the estate tax burden on your estate. The estate planning attorneys at Twomey, Latham, Shea, Kelley, Dubin & Quartararo are available at your convenience to answer your questions, review your current estate tax plan to ensure it continues to meet your needs or to discuss the implementation of an estate tax plan.
 Your basis in the property can increase or decrease while you own the property. If depreciation deductions are taken on the property, the basis in the property decreases. If improvements are made to the property, the basis increases.