Share

2021 Estate Tax Exemption: How to Prepare for the Biden Estate Tax Plan

By Matthew R. Adams on August 18, 2021
Categories: FINANCIAL PLANNING, TAXES

President Joe Biden recently revealed the American Families Plan, a 10-year plan to raise $1.5 trillion primarily through increased taxes on the country’s highest earners. The proposal has not yet reached Congress for debate, but it’s still important to understand the details involved, especially those that may affect your estate and overall financial planning. The Biden estate tax exemption 2021 plan has several changes that, if enacted into law, could impact how high net worth individuals pass on assets for generations to come. Here’s everything you need to know about the Biden estate tax exemption 2021 plan.

Biden tax proposal impact on estate planning

There are three primary tax changes in the Biden proposal that, if passed into law, could have a dramatic impact on estate planning:

Increase in capital gains and qualified dividends tax rate for top earners

If you have questioned, “what is Biden’s tax plan and how will it affect me as a top earner?”, this change may have the largest impact on your annual tax return. President Biden has proposed a higher tax rate on both long-term capital gains and qualified dividends, but only for the nation’s highest earners. Currently, the long-term capital gains tax rates for those earning $441,451 or more is 20%. Earners at similar income levels also pay 20% tax on qualified dividends.

The White House tax proposal increases the top rate for both types of investment income to 39.6%, but only for taxpayers whose annual income is $1 million or more. If enacted, the new rate would place the U.S. as having one of the highest top capital gains taxes among the world’s developed countries.

A potentially higher capital gains rate impacts estate planning, particularly in light of other related changes in the tax proposal.

Elimination of “step-up in basis”

The first estate tax exemption under fire in the Biden tax proposal is the elimination of the “step-up in basis.” This strategy has traditionally been used to avoid a hefty capital gains tax on an inherited asset. As the current law stands, heirs may use the asset value at the time of inheritance to calculate gains, rather than from the purchase date. President Biden plans to eliminate this tactic altogether.

The elimination of this federal estate tax exemption proposed in 2021 would apply to gains of $1 million or more for single tax filers and $2.5 million or more for couples (including a $500,000 capital gains exclusion on a primary residence). Paired with a higher capital gains tax rate, this could potentially diminish a beneficiary’s inheritance. For instance, say your aunt bought 500 shares of a stock in 1999 at $45 each, for a total investment of $22,500. Today, that stock is worth $5,000 a share the holding would be worth around $2.5 million. Under current tax law, if she bequeathed you that stock and passed away in January 2021, you would only owe capital gains tax on the appreciation that occurred since the time of her death and the time you sold the stock.

Under the potential change from President Biden, you would instead be responsible for the full appreciation from the date your decedent purchased the stock — which would amount to a total gain of $2.47 million.

Capital gains tax applied to dynasty trusts every 90 years

A dynasty trust is a type of irrevocable trust that allows transferred assets to be exempt from estate and gift tax as long as it’s within the limit for the federal estate tax exemption. In 2021, the exemption limit is $11.7 million. It has been used as a way to pass on wealth for multiple generations without the beneficiaries having to pay any estate taxes on the proceeds. However, income tax does need to be made on any withdrawals.

Since a dynasty trust is an irrevocable trust, distributions can only be made using whatever terms were outlined when the trust was created. Neither the grantor nor the beneficiary may make changes. Additionally, some states have a “rule against perpetuity,” limiting how many generations the trust may be passed onto.

The Biden tax plan has targeted dynasty trusts as part of his new tax proposal. The policy would enforce a cyclical charge of capital gains tax on appreciated assets every 90 years. As a transitional rule, President Biden’s plan would start the 90-year period on January 1, 1940. That would trigger a capital gains event on appreciated assets as soon as December 31, 2030.

Estate tax rate staying put

The 2021 estate tax exemption is currently $11.7 million, which was an increased amount from $5.45 million, enacted under the Tax Cuts and Jobs Act of 2017. For couples, the exemption is $22.8 million. This temporary exemption is set to sunset in 2025 and would revert to the previous limit (likely around $5.8 million when adjusted for inflation).

President Biden did not include a plan to lower the estate tax exemption before the scheduled sunset date at the end of 2025. A plan introduced by Senator Bernie Sanders (VT) and Representative Jimmy Gomez (CA) proposes repealing the estate tax exemption to 2009  levels. If enacted into the current law, this would reduce the exemption to $3.5 million for single filers and $7 million for couples.1

There was another pleasant surprise in the Biden tax plan compared to the president’s campaign issues. There is no proposal to increase the estate tax rate for assets beyond the exemption. Currently, the estate tax is set at 40% and a tax hike is no longer part of President Biden’s plan.

Uncertainty in final ruling

With a new administration in the White House and a tighter political balance in Congress, it’s no surprise to hear of new tax proposals. However, it’s important to remember that none of these policies are actually in effect yet. Currently, there is no date set for voting on the American Families Plan. Additionally, tight margins in both the Senate and Congress could make the bill difficult to pass. It’s important to stay up-to-date on the progress of the bill and what elements remain before it is potentially signed into law.

Potential solutions for estate plan

The introduction of the American Families Plan certainly opens the door to have a conversation with your wealth management team as the grantor. Some individuals may decide to make certain gifts before the legislation is finalized, especially on stock that has greatly appreciated over time. It may also be time to evaluate the use of a trust or retirement account for assets that you’ve held onto for a long time — this can help reduce the impact of losing the step-up in basis.

Your financial advisor can also help evaluate your time horizons to determine whether to sell or hold assets. The potential benefits need to exceed the higher capital gains tax, if the president’s tax plan goes through. The potential hike in capital gains also highlights the importance of diligent tax loss harvesting in your portfolio. If you are interested in learning how to reduce capital gains tax, it’s key to understand that any strategy that lowers your unrealized capital gains while keeping your inherited asset allocation balanced could be beneficial if this tax is increased. It is key to note when evaluating your rental real estate holdings, that a 1031 tax exchange has it’s own implications described in the American Families Plan, separate from the 2021 estate tax plan proposed by Biden, though both proposals have various financial implications.

Bottom line

With potential tax changes on the horizon, it’s good to at least start brainstorming strategies with your financial advisor before any legislation is finalized. You may not need to execute any actions yet, but it’s smart to have a back-up plan to respond to any changes that lie ahead.

For an experienced wealth management team to help you navigate these uncertainties, reach out to Dowling & Yahnke Wealth Advisors today.

Source:
  1. https://americansfortaxfairness.org/issue/senator-sanders-rep-gomez-unveil-99-5-act-reforming-estate-tax/

RELATED ARTICLES

House for sale

1031 Exchange Biden Adjustments: 1031 Exchange Explained

Read Now
2021 Estate Tax Exemption: How to Prepare for the Biden Estate Tax Plan

California Business Owners Potential Tax Savings: AB 150

Read Now
Woman smiling while taking a trip on a boat

Tax and Retirement Planning Guide

Read Now

OUR TEAM

Discover the people who make Dowling & Yahnke one of San Diego’s top wealth management firm.

MEET THE TEAM

CONTACT US

Our team is available now to discuss all of your financial goals.

SEE INFO