One of Joe Biden’s campaign themes is that an overhaul of federal taxes is needed, in order to ensure that corporations and high-net-worth individuals pay “their fair share”. In a debate prior to him receiving the Democratic Party’s nomination, he adopted the theme of “rewarding work, not just wealth”.
There has been much speculation about what a Democrat Administration might do to modify the tax treatment of inherited and gifted wealth. The Biden team has provided only limited information about Mr Biden’s plans. Nevertheless, Joe Biden has signalled that he supports raising estate taxes and changing the taxation of capital assets passing when the owner dies.
This aspect of federal taxation has not been a theme of the Trump re-election campaign. Following the legislation passed in 2017, towards the end of President Trump’s first year in office; no further changes to the federal taxation of inherited and gifted wealth are being floated. Nevertheless, starting to pay for all the Federal Government’s costs associated with COVID-19 will be a necessary point of focus for a Trump Administration, should the President be re-elected for a second term. Taxes will need to be raised somewhere.
What are the current rules regarding inherited and gifted wealth?
As a reminder of the current rules 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.
- Legislation 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 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”).
So, what changes might a Biden Administration want to introduce?
As mentioned earlier, there have been hints about a change to the way inherited and gifted wealth is taxed, but little by way of detail.
In the past 50 years, there have been 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.
We have seen the following smoke signals about Mr Biden’s current thinking, including:
- A reintroduction of a previous Obama Administration proposal to impose a mark-to-market tax on appreciated capital assets upon the death of their owner. That original plan 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 then 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 is a lack of clarity because some statements made by Mr. Biden 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 has appeared to indicate that he wishes to change the treatment of capital gains at death.
- The lack of precise details from the Biden Campaign may be because the exact detail of future taxation policy remains to be distilled. It is highly unlikely that an incoming Biden Administration would propose legislation that was retroactive to a date in 2020.
- An obvious target for a Democrat Administration with a Democrat controlled Senate and House 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.
Notably, any significant change to the federal taxation of inherited and gifted wealth by Mr Biden will require that in the November elections the Democrats:
- win the Presidential election, and
- emerge with sufficient Senate seats to command a simple majority there, and
- retain their present majority control of the House.
If those three conditions prevail, change will be by means of budget reconciliation legislation, which comes with a limited shelf life.
Is there anything I should be doing now before the November elections?
Ahead of the election result, it would be a pure gamble to anticipate specific legislative change and to commence juggling assets to best fit into that imaginary tax future.
There may be no tax changes. This could be the case if either President Trump is re-elected, or a Republican controlled Senate is able to block any proposals emanating from a Biden Administration.
However, if there are tax changes, the window period for implementation may be short, especially if the outcome of the Presidential race is subject to dispute. As such, in the light of contradictory smoke signals from the Biden Campaign, a useful current exercise would be:
- Determine which of the possible tax policies would represent a ‘worse case’ scenario when applied to your own circumstances.
- Discuss with your tax advisor what planning opportunities you might have to address your own worst-case scenario, both with and without an accompanying hike in taxation of capital gains.
- Take time to consider if any potential tax planning suggested by your advisor is unacceptable to you for non-tax reasons; for example, you don’t want to give valuable property away so soon.
Following this approach will mean you avoid having to make what might otherwise be an instant decision during a narrow window of opportunity. The “Do I really want to do this?” question will have been thought through ahead of the crux moment.
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 to the right.