As the United States experiences a major political shift, it is important to consider the probable changes to tax law that the new party in power will likely implement. The extreme likelihood of these changes to the current tax law and exemption limits creates a window of opportunity for clients’ to take advantage of.
The repeal of the TCJA and the reappearance of proposals made or considered during the previous Obama/Biden administration would significantly change the current wealth tax transfer landscape. Although the structure and effective dates of any such changes are unknown, they have the potential to substantially constrain currently available wealth transfer strategies. Here are potential changes that we believe deserve attention.
1. Decrease the current tax exemption i.e Gift, estate and generation-skipping transfer [GST]). The repeal of the TCJA would reduce the per-person unified tax transfer exemption as indexed for inflation from its current level of $11.7 million to $5 million (or approximately $5.5 million if some version of inflation-adjusted indexing were applied). Some believe that the legislation could reduce the exemption even further, possibly to the $3.5 million level previously proposed by the Obama/Biden administration. This potential change should motivate clients with larger estates to consider using their full exemption(s) as soon as possible. Clients who had fully used their exemptions as of the end of last year can still make use of the additional $120,000 that inflation adjustments added as of Jan. 1, 2021. Certain strategies may permit transfers made early in 2021 to be modified later if it’s determined that they occurred after the effective date of a decrease in the exemption.
2. Increase the current unified transfer tax rate. The current rate of 40% wouldn’t be impacted merely by repeal of the TCJA. President Biden hasn’t publicly advocated for a rate increase, but the prospect of one reinforces the importance of using currently available transfer tax exemptions and potentially even making taxable gifts to fully use a GST tax exemption that exceeds an available gift tax exemption.
3. Eliminate the step-up in tax basis at death. Under current law, appreciated assets included in an estate receive an income tax basis step-up to their date-of-death value or their value six months later. President Biden has made an alternative proposal. It’s unclear whether this change would be limited to carryover basis for inheritors or involve a more drastic change that would impose an income tax on appreciation at death. A carryover basis approach was actually enacted in 1976, but implementation of it proved to be so difficult it was repealed before it took effect. Although this change seems unlikely in the near term, its possibility can’t be totally ignored.
4. Bring back proposed restrictions on valuation discounts. The Obama/Biden administration issued proposed regulations in 2016 that would meaningfully restrict the use of fair market value discounts when assets transferred are subject to lack-of-control, marketability or other restrictions. These proposed regulations were withdrawn in 2017, but it seems likely some version of them will return under the new administration. This prospect provides additional incentive to consider as soon as possible any wealth transfer strategies to which a valuation discount may apply.
5. Impose restrictions on the use of grantor retained annuity trusts (GRATs) and GST trusts. The potential for these changes makes it important for anyone considering a GRAT strategy or putting GST in place to do so as soon as possible.
6. Change grantor trust status. If ordinary income tax rates and rates on LTCGs for high-income taxpayers are increased, families with grantor trusts should consider whether the benefit of terminating grantor trust status—if those trusts will qualify for lower tax rates—exceeds the benefit of having the income tax payments decrease the grantor’s taxable estate.
7. Modify trusts producing meaningful amounts of taxable income. If income tax rates on ordinary income or LTCGs are increased for high-income taxpayers, trustees or other fiduciaries with the authority to do so should consider dividing individual trusts into multiple smaller trusts if they’ll qualify for lower income tax rates.
Despite the uncertainty, clients’ should begin considering now how these possible changes might affect them and whether they want to implement certain strategies sooner rather than later.
