It is always important when considering year-end tax planning to include estate and gift tax considerations, but this year’s presidential election paired with the economic downturn makes estate planning especially important. It has been reported that Presidential candidate Joe Biden wants to roll back the estate tax exemption to as little as $3.5 million from the current amount of $11.58 million. He has stated that he also wants to remove many provisions of the tax reform law commonly known as the Tax Cuts and Jobs Act (TCJA), particularly those that benefit wealthy individuals. And lowering the exemption would be consistent with a campaign that is predicated on tax increases for the wealthy.
The potential decrease in the estate tax exemption isn’t the only reason to take a second, or even a first look at your estate plan. More concretely, candidate Biden has proposed removing the basis step-up for assets passed at death. The basis step-up generally provides that the basis of an asset (the starting point for calculating gain or loss on a sale or exchange) is increased to the fair market value of the asset as of the date of the taxpayer’s death. Keep in mind that for many assets, the basis is unknown, and that the IRS assumes a basis of zero without a reasonable determination of basis.
A Closer Look at Biden’s Plan to Eliminate Basis Step-Up
Even without a decrease in the exemption amount, this proposed change could have a significant impact on taxpayers. Without the basis step-up, beneficiaries could have to pay tax on property that has appreciated for many years when they did not own it. And unlike a change in the exemption amount, this will adversely impact smaller estates, as well.
As an example, consider a person (“Decedent”) who passes away in 2021. Decedent held land that is worth $1.5 million at the time of his death, which is his only significant asset. He inherited this land from his parents (after their passing — receiving a basis step up at that time) in 1967 when it was worth $125,000, and he has not paid any income or estate tax on it (assume his parents purchased it for $1,500 in 1932). Although no estate tax would be due even if the exemption amount were lowered to pre-TCJA levels or lower, the Decedent’s heirs could face a significant future tax liability if the basis step-up is removed. If the Decedent’s heirs sold the land immediately following the Decedent’s death, the heirs would have to pay income tax on the difference between the 1967 valuation of $125,000 and the 2021 valuation of $1.5 million, because the heirs would not benefit from the 2021 basis step-up. Under current law, the heirs would likely pay $0 tax on an immediate sale, because the selling price would presumably be equal to the appraised value as of the date of death.
Other Estate Considerations
If President Trump is re-elected and the current estate tax rules remain in place for at least four more years, the economic downturn still presents a unique opportunity for those looking at estate and gift tax savings. The U.S. saw a 32% decrease in GDP (economic output) in the second quarter of 2020 as a result of the coronavirus. Correspondingly, the value of many assets has decreased as a result of this downturn. This means that the tax consequences of a transfer of assets may be reduced, as well.
Consider a hypothetical married couple with a family business (an LLC) that they run with their three children, and the couple is looking to retire. Before the pandemic, the 25 LLC units that they held were valued at $15,000 per unit. Thus under current law, the parents could give roughly two units to each child per year without needing to utilize any of their lifetime exemption amount. This would leave them with 19 LLC units and approximately three more years of ownership. But if the current value decreased to $5,000 per unit as a result of the downturn, they could gift six units per child per year and transfer the business in as little as two years. This could be vitally important if the parents own other appreciated assets, as gifting the LLC units tax-free creates room under the lifetime exemption for those other appreciated assets.
Thus, the unique combination of an election year and an unprecedented economic downturn presents a valuable opportunity to establish or revisit an estate tax plan. But this opportunity won’t last long. There are already signs that the economy may recover in 2021, and the election is only a few short months away. In short, now is the time to talk to your local CBIZ tax professional regarding your estate plan.
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