I try very hard not to be political in these blog posts. I also try not to speculate on what the government may or may not do as they frequently compromise in an unpredicted manner. However, I would be remiss if I didn’t talk about the fact that Joseph Biden is ahead in most of the polls and the fact that his platform has publicly indicated it wishes to reduce the federal estate and gift tax exemptions.
If he wins, should you make a gift before 2021?
Current Gift and Estate Tax Law
Under the current federal Gift and Estate tax law, each person has a $10,000,000 exemption that has been indexed for inflation. Accordingly, in 2020, you can pass along $11.58m to your loved ones before you incur a gift or estate tax. Additionally, these taxes are coordinated, so that if you gift away $7m, it uses up part of your $11.58m exemption. Furthermore, this exemption is portable. So if you are married (to a US citizen), combined, you receive a $23.16m exemption. This exemption amount is scheduled to increase through 2025. In 2026, the law sunsets and is reduced down to a $5m exemption, indexed for inflation.
Once you gift away or bequeath more than the exemption amount, there is a flat 40% tax. Currently, roughly less than 0.2% of the people who die each year pay the estate tax. (See: here) So it affects very few people, and only those who have significant wealth.
Finally, when a person dies, regardless of whether they pay an estate tax or not, they receive a step-up in basis for most of their assets. As a result of the step-up in basis rules, you can inherit a low basis asset, then sell it with practically no capital gains tax consequences. The only capital gains tax would be as a result of the change in value from the decedent’s date of death to the date of sale.
The combination of a large federal gift and estate tax exemption along with the step-up in basis rules alongs for significant gaming of the system by the wealthy. To understand some of the planning that can be done, read my post in 2017 about the Tax Cuts and Jobs Act.
Proposed Gift and Estate Tax
Joseph Biden’s website does not offer clear insight on what he proposes with respect to the gift and estate tax rules. However, according to various news sources, he wishes to reduce the federal estate tax exemption anywhere from $3.5m per person to $5m per person, reduce the gift tax exemption down to $1m, keep portability, potentially change the rules about step-up in basis, and increase the tax rates.
Some have speculated that the Democrats and Joseph Biden will get rid of step-up rules all together. One of the main policy reasons to have an estate tax is as a substitute for a capital gains tax upon death. Therefore, I personally think that if he wins they will either reduce the estate tax exemption, eliminate the step-up rules, or do some sort of hybrid solution. I doubt they will reduce the estate tax exemption significantly AND get rid of a step-up rule completely.
Additionally, I personally think it is highly unlikely that they will reduce the tax exemptions too much. It will likely be too politically unpopular for most in the House or the Senate.
Would the Law Be Retroactive?
The short answer is, who knows. Legally, I think there is enough caselaw to allow it. Whether a Conservative Supreme Court would uphold it is another matter. Ironically, many of the very conservative justices, such as Justice Thomas and the late Justice Scalia, in United States v. Carlton, have shown clear deference to allowing the legislature to enact tax rules retroactively.
Even if the law is retroactive, they are highly unlikely to try to claw back gifts made prior to 2021. It would take a lot of extra political will to enact such a law. There is an inherit unfairness component to that which most people dislike.
What Can You Do to Minimize Taxes?
If you are concerned about a reduced estate tax, then, simply put, you can make a gift before 2021 to your loved ones or a trust for their benefit. If you are charitably inclined, there are also many estate planning techniques that can be implemented as well that will reduce the tax impact. Since it takes a while to develop these types of estate plans even during normal times, we strongly advise you to reach out to your estate planning attorney as early as possible if you wish to consider any tax planning options.
