It is very likely that significant changes will be made to our tax laws in 2021. The Biden government and various democratic lawmakers have proposed a variety of changes to our tax system for businesses and individuals. Which of these proposals will be adopted and in which form is difficult to predict, especially given the tight majority of Democrats in the House and Senate and the complexity of tax legislation. However, it is likely that some changes will be made. The purpose of this article is to summarize the possible changes in tax laws that will affect estate planning clients and to recommend possible actions.
Some possible legislative changes are as follows:
- An increase in the inheritance tax rate from 40% to a range of 45% to 77%.
- A reduction in the inheritance tax exemption (currently $ 11.7 million per person) to between $ 3.5 million and $ 5 million per person.
- The gift tax exemption reduction is only $ 1 million per person (as of 2009, the gift tax exemption was less than the inheritance tax exemption, which is supposed to prevent lifelong gifts).
- A limit on the length of time a trust can exist without being subject to a generation skipping transfer tax (currently there is no time limit, which is one of the main advantages of Dynasty Trust planning). For example, one suggestion is to collect the tax every fifty years.
- Elimination of the “Basis Step Up” for credit balances in the event of death. Currently, most assets are given a base step to the death-at-death market value. It is possible that the top-up will not be completely eliminated and a cap of 1 million will be set instead.
- In conjunction with no increase in the tax base, a disposal of assets in the event of death would apply, triggering capital gains tax if the value of the assets exceeds the actual cost base or the amount allocated in the event of death. This proposal is especially important as the capital gain ratio is increased and will have a large impact on family business owners and all property owners. The presumed sale rules may also apply to gifts.
- Restrictions on the use of irrevocable Grantor Trusts, including the time frame for the term of a Grantor Retained Annuity Trust (typically a GRAT has a term of two years and a suggested minimum term of ten years).
Given the uncertainty of tax laws, it is important to review your estate plan to make sure it carries out your intent in a tax efficient manner. Some planning options to consider depending on your circumstances:
- Create a “Spouse Lifetime Access Trust,” an irrevocable trust that benefits a spouse for life. The spouse can act as trustee. Funding this trust would use your gift tax exemption. The trust can be structured to benefit both your children and your spouse.
- Create an irrevocable trust that will benefit children, grandchildren, and other offspring.
- Direct gifts.
- Funding 529 plans.
- Customers with major taxable events (like selling a business that year) can consider charitable planning techniques like a Charitable Remainder Trust or Charitable Lead Trust (these trusts give you an income tax deduction but also benefit your family). Other customers may want to defer significant charitable donations for years to come when the charitable income tax deduction may be more valuable due to higher tax rates.
It is important to regularly review your estate plan regardless of the legal framework. However, in the current environment, it is especially important to make sure that your plan is maximizing the benefits of the tax laws.