One of Joe Biden’s campaign themes was the need for an overhaul of federal taxes. The President-elect and his team spoke of wanting to ensure that corporations and high-net-worth individuals pay “their fair share”. In a debate prior to Mr Biden receiving the Democratic Party’s nomination, he adopted the theme of “rewarding work, not just wealth”.
This has led to speculation about how the incoming Democrat administration might seek to modify the tax treatment of inherited and gifted wealth. In the course of the election campaign, the Biden team provided only limited information about how his campaign theme might be incorporated into federal tax law. Despite the absence of that detail, Joe Biden has signalled that he supports raising estate taxes and changing the taxation of capital assets passing when the owner dies.
What are the current rules regarding inherited and gifted wealth?
Subject to substantial lifetime exemptions, at present an integrated system applies when the beneficial ownership of property changes, either:
- because of a gift made during the previous owner’s lifetime, or
- by way of bequest, on the death of the previous owner.
The combined estate and gift tax exemption for 2020 stands at the all-time high of $11.58 million per person ($23.16 million per married couple).
- Legislation that passed in December 2017 doubled the previous exemption but provided for the enhanced amount to automatically ‘sunset’ at the end of 2025.
- Thereafter, the exemption returns to the amount that would be available for 2026 under the pre-December 2017 law.
- Nowadays, Congress passes tax changes with a ‘sunset’ date because procedural constraints generally make any permanent legislative change difficult.
Depending on whether property is either inherited, or alternatively acquired by way of gift, different rules determine how to compute basis for the new owner. Basis is the monetary figure that reflects a taxpayer’s investment in that property. The amount of a taxpayer’s basis will determine the extent to which gain, or loss, arises when there is a disposal of the property.
- When a person inherits an asset, their basis is the asset’s fair market value at the time of the previous owner’s death. This is called a ‘step-up in basis’ because the basis of the decedent’s asset is stepped-up to market value.
- With gifts made during the donor’s lifetime, the recipient generally takes over the basis of whoever made the gift (‘carryover basis’).
What changes might the incoming Biden administration try to introduce?
Although the campaign rhetoric included strong hints about a change to the way inherited and gifted wealth is taxed, little was provided by way of detail.
From a historical perspective, the last 50 years has seen three separate attempts to make significant changes in this area of taxation. For different reasons, each of those attempts either failed or fizzled out. Consequently, the relevant parts of the Internal Revenue Code remain essentially the same as they were prior to the first attempt at change, as long ago as 1976.
- One possibility that might be in the President-elect’s mind is a reintroduction of a proposal made while he served in the Obama administration. This would impose a mark-to-market tax on appreciated capital assets, upon the death of their owner. The original Obama version would have been accompanied by repealing the stepped-up basis, but subject to several exemptions. These included a general exemption for the first $100,000 in accrued gains ($200,000 per married couple).
- This proposal never really got out of the starting gate. However, it is a policy with which the former Vice President will be familiar.
- The US Department of the Treasury estimated that, if combined with raising the capital gains rate to 28 percent, this proposal would raise $210 billion over 10 years. Ninety-nine percent of the projected revenue raised would come from the top 1 percent of households ranked by income.
- However, there remains a lack of clarity on the exact intent.
- Some of the President-elect’s campaign rhetoric might suggest that he has in mind to eliminate the basis step-up, without necessarily imposing a mark-to-market tax on death.
- Then, at other times, Mr Biden appeared to indicate that he wishes to change the treatment of capital gains at death.
- Irrespective of any desire for fundamental change, an obvious target for the incoming Democrat administration is the current estate and gift tax exemption of $11.58 million per person ($23.16 million per married couple). This could either be repealed in its current format or, alternatively, have the period before its ‘sunset’ shortened.
- Concerns have been expressed in some quarters about the possibility of retrospective legislation.
- It is highly unlikely that an incoming Biden administration would propose legislation that was retroactive to a date in 2020.
- However, the first year of the Trump Presidency provides a recent example of retrospective legislation. The tax measures signed into law by President Trump just prior to Christmas 2017 had an effective date of January 1, 2017.
What are the chances of Biden administration proposals becoming law?
It is a long journey from the crystallisation of a proposal to its incorporation in the US Internal Revenue Code. Proposed legislation needs to navigate three separate hurdles before becoming law. It requires:
- approval by the House of Representatives (the House).
- approval by the Senate.
- signature by the President.
In recent decades, the once bi-partisan approach to tax reform has been notably absent. Unless both the House and the Senate are of the same political persuasion as the President-elect, tax policies espoused during the election are liable to remain pipe dreams for Mr Biden.
The recent elections left the Democrats with continued control of the House. However, the final composition of the Senate will not be known until late in the first week of January 2021. This is when the electors in Georgia decide on their two representatives in the Senate. Unlike most States, Georgia does not have ‘first past the post’ elections to the Senate. Because no candidate scored in excess of half the votes cast in the November 2020 election, the top two candidates in both constituencies will have a run-off election in January 2021.
If both of Georgia’s seats in the Senate were to go to the Democrats, the balance in the 100-member Senate would be 50:50 between Democrats and Republicans. However, such a tie would effectively mean Democrat control. When a Senate vote is tied, the (normally non-voting) Chair of the Senate has a casting vote. As the Vice-President is the Senate Chair, that would deliver effective Democrat control.
Absent a Democrat controlled Senate, the Biden administration will have to reach out for support from a few moderate Republicans if it wants to implement any tax changes. Such a scenario is not impossible but would probably involve a degree of compromise and the resultant watering down of what President-elect Biden talked about during the election campaign.
Any legislation which does manage to get Senate approval will follow a process known as budget reconciliation. That was the route taken with the tax legislation in 2017. Getting new law by this route does not deliver permanent change. The resulting legislation comes with a limited shelf life before a ‘sunset’, followed by a reinstatement of prior law. To get a permanent change through the Senate effectively requires 60 votes. It is highly unlikely that sufficient Republican Senators could be brought onside to achieve the necessary 60 votes.
Is there anything I should be doing before 1 January 2021?
If a Biden administration finds itself able to make wholesale changes to the US Federal taxation of inherited and gifted wealth, backdated to January 1, 2021, any avoiding action by taxpayers must be taken in 2020.
Anyone who has been considering a major transfer of wealth and is in the late stages of the necessary due diligence, should consider ensuring that the relevant transaction(s) do take place before January 1, 2021. If you intend to do something regardless, then taking the necessary actions in 2020 will almost certainly ensure that current law applies to those transactions.
Meaningful, estate and gift planning will generally involve a high value in assets and/or liquid funds being transferred from one person to another.
Only if the Democrats win both of Georgia’s seats in the Senate, will the incoming Biden administration have the means to get its unadulterated tax wishes through Congress. Ahead of knowing those Georgia results, it would be a pure gamble to anticipate specific legislative change and then commence juggling assets in 2020 to best fit into that imaginary tax future. After all, there may be no meaningful tax changes, because of a Republican-controlled Senate.
Would you like to know more?
If you would like to discuss the above or have any questions about how potential changes to inherited or gifted wealth may impact you, please get in touch with your usual Blick Rothenberg contact or one of the partners behind this article.