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Why has President Biden gone quiet on Estate Tax reform?

John Havard (Consultant, US/UK Private Client) looks at why President Biden has gone to ground on reforms to US Federal Estate Tax.

A theme of President Biden’s election campaign was: “Tax reform that rewards work, not wealth”. In summary, candidate Biden made it clear that part of his ‘not rewarding wealth’ agenda involved changes to the Federal Estate Tax. Numerous references were made to the ‘unfairness’ of this particular tax and he indicated a desire to reverse the large increase in the Estate & Gift Tax exemption introduced by the Republicans in 2017.

Since taking office in January 2021, the President has not developed on this campaign theme. There had been expectations of some detail emerging when the President addressed a joint session of Congress on 28 April. However, both the President’s speech and the accompanying White House ‘fact sheet’ failed to make any mention of Estate Tax reform.

In May, the US Treasury Department issued a ‘Green Book’ which contained explanations of the Biden Administration’s revenue proposals for the current fiscal year. Again, no mention of making changes to the Estate Tax.

While this ‘radio silence’ has generated much comment, there is no generally accepted explanation for the President apparently having gone to ground on this issue. Suggestions include:

A. Having a legislative package of manageable size

The proposed corporate and individual tax increases announced in the President’s speech are intended to fund a wide array of new spending initiatives. Most of the speech was devoted to how money would be spent, with very little time taken to explain how the necessary funds would be raised.

If everything mentioned in the speech finds its way into the same legislative package, that will amount to a very large Bill being introduced in Congress. With the absence of bi-partisan consensus, legislation will need to be passed using the budget reconciliation process if a blocking filibuster in the Senate is to be avoided.

The practicalities of budget reconciliation are that introducing a further revenue raiser would see further spending measures being added too.

As a result, perhaps Estate Tax reform is being kept on hold, pending a further legislative package later in the President’s term of office.

B. Potential obstacles in the legislative process

Democrat control of the Senate depends on the Vice President’s casting vote. There has been no indication that any moderate Republican Senators might lend their support to the President’s proposals. Furthermore, unless the support of all Democrat Senators is retained, the President’s proposals will be going nowhere.

Democrat Senators up for re-election in 2022 will be particularly concerned if anything in the President’s proposals might threaten upsetting the electorate in their own constituencies. At the same time, the radical wing of his party will be urging the President to be bold.

Unless the support of all Democrat Senators is retained, the President’s proposals will be going nowhere.

Informal indications from Capitol Hill are that the package announced in the President’s speech was the result of considerable due diligence on the part of the Biden team. They canvassed opinion in Congress beforehand, to ensure that each line item in the President’s proposals enjoyed sufficient support amongst the lawmakers in Congress.

This leads to a view that the absence of proposals to reform the Estate Tax is because the necessary support for such a line item could not be secured. Perhaps there were already sufficient hot potatoes in the package. Including another might reduce the chances of getting anything through the legislative process.

C. Something more fundamental than ‘reform’ of the Estate Tax is likely to emerge

In his speech, the President announced an intent to abolish the ‘step-up’ in basis for inherited assets, which might be an indicator that he has in mind a fundamental change to the Estate Tax.

President Biden’s objection to a step-up in basis is that it results in certain capital gains never being taxed. For example, Taxpayer X dies in the first quarter of 2021 and Taxpayer Y inherits Taxpayer X’s holding of Amazon shares. Taxpayer X purchased the Amazon shares for $1,000 at the initial offering in 1994.

Today’s value of those Amazon shares is approximately $18bn. On taking title after probate, the new owner (Taxpayer Y) would be able to immediately sell the Amazon shares without incurring a capital gain. All because of the step-up in basis to $18bn. This is in stark contrast to what the situation would have been had the shares been gifted to Taxpayer Y, during Taxpayer X’s lifetime. An asset transfer by means of lifetime gift would have resulted in Taxpayer Y receiving a carry-over of Taxpayer X’s $1,000 basis.

It is unclear exactly how the President envisages abolition of ‘step-up’ in basis taking place, although some detail is now contained in the ‘Green Book’. At a simple level, it might mean no more than amending the basis rules so that inherited property is treated the same way as gifted property.

However, there is a flaw in the simple proposition that abolishing step-up in basis will result in more tax being collected. In the earlier example involving Amazon shares, tax will only be collected on gifted shares (with a carry-over basis) if the new owner sells them.

Under the current rules, there will be no capital gains even if the shares received by way of a gift are not sold, or otherwise disposed of, during the new owner’s lifetime. In order to guarantee an increase in tax collections, the law will need to be amended to create a deemed disposal for capital gains purposes when title to an asset changes by way of a lifetime gift or bequest on death. This is the approach set out in the ‘Green Book’, although the idea had already been aired from outside the Administration.

In late March of this year, some radical Democrat Senators introduced a Bill, one feature of which would treat assets as being sold at their fair market value if transferred by either gift or bequest. It is possible that this was some sort of ‘tester’, prior to the idea becoming a government-endorsed policy.

Taking this approach would dovetail neatly with another idea. This was already being aired by radical Democrats but subsequently emerged as the main recommendation in an OECD report published in May. The suggestion is that rather than using the current Estate & Gift Tax structure to tax either a deceased person’s estate or the person making a gift, the focus should change to instead tax the recipients of gifts and bequests. Under this approach, recipients would be taxed at graduated rates, based on their cumulative receipts of gifts/bequests. If such an approach were to be adopted, it would mesh neatly with treating assets as being sold at their fair market value if transferred by either gift or bequest.

Would you like to know more?

If you would like to discuss the above, please get in touch with your usual Blick Rothenberg contact or John Havard using the details on this page.

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