Joseph R. Biden, Jr. will unseat current President Donald J. Trump in January, making him the 46th President of the United States. With a record-breaking voter turnout and a stressful time awaiting election results, most Americans are now turning their focus to what changes new leadership may bring. One area to review in light of Biden's victory is your estate plan, and specifically estate tax changes that could affect your family.
A Reminder About the Tax Cuts & Job Acts (TCJA) of 2017
President Trump enacted the Tax Cuts & Job Acts (TCJA) in 2017. Among other things, this act greatly increased the amount of money a person or couple could pass down to children or charity free from estate taxes. Prior to the TCJA, this number was $5,490,000 for individuals or $11,980,000 for couples in 2017. Any amount gifted or passed on above this amount would be taxed at a rate of 40 percent. Since the passing of the TCJA, the exemption limit has increased to $11,580,000 per person or $23,160,000 for couples.1
This legislation is meant to remain in effect until January 1, 2026 when it would, presumably, revert back to pre-TCJA exemptions levels (adjusted for inflation). Unless President-elect Biden reverses these orders.
What Does Biden's Win Mean For High-Income Filers?
Biden is cited as saying he’d repeal TCJA benefits for high-income filers - which, in all likelihood, would include the TCJA’s higher tax-exempt limit for estate inheritances and gifts.2 If this becomes the case, this would affect those who may be planning on passing along an estate inheritance greater than $5.49 million (this number is based off of 2017 pre-TCJA numbers, but would be adjusted for inflation).
What Should You Do to Prepare For a Potential Estate Tax Change?
With Biden winning the election, we could see tax changes, including changes to estate and gift tax exemptions. The timing and extent of these changes will depend on many things, including control of both houses of Congress. It seems clear that Democrats will retain control of the House. There are runoff elections for two Georgia Senate seats on January 5th and if both of these are won by Democrats the results will be a 50/50 tie in the Senate, giving the tie-breaking vote to Kamala Harris as Vice President.
Whether in 2026 or sooner, it seems likely that there will be a 50% drop in the tax exemption limit which may affect your future gifting and estate planning. There are a few things you can do now to alleviate the potential tax consequences. One strategy would be to make gifts to your children or charities and use as much of the exemption as you can starting in 2020 before any tax changes go into effect.
For those inclined to give to charities, gifts of highly appreciated stock often make for tax-smart giving, since the contribution amount is based on fair market value, but no capital gains tax needs to be paid on the contribution. Contributing assets now to a donor advised fund allows you to take an immediate deduction but then allows you to take your time in parceling out the money to various charities you select.
In some cases, gifting or selling portions of your estate to certain types of trusts can help to preserve your estate as you prepare to pass it on to children or grandchildren.
There are two basic types of trusts used for estate-planning purposes:
- Revocable trust – can be changed or cancelled at any time by the creator (grantor) who often acts as the trustee. Income tax is paid by the grantor. Trust becomes irrevocable upon the death of the grantor.
- Irrevocable trust – cannot be modified or revoked by the grantor without the permission of the beneficiaries. Removes assets from the estate of the grantor. Used by persons with large estates to reduce death, gift, and estate taxes.
Common types of irrevocable trusts include:
- Grantor Retained Annuity Trusts (GRATs) – An irrevocable trust created for a certain period of time from which the grantor (creator) receives yearly interest paid out by the trust (at a rate based on 3-9 Year Treasury yields). When the time period expires, the beneficiary receives the assets tax-free. GRATS are especially popular with individuals who contribute startup shares in pre-IPO companies for the benefit of their children.
- Intentionally Defective Grantor Trusts (IDGTs) – An irrevocable trust that is “defective” in the sense that it is “effective” for estate tax purposes in that it removes the assets from the grantor’s estate but “defective” for income tax purposes in that trust income will be taxed at the grantor’s personal income tax rate which is often lower than the rate applicable to the trust.
- Charitable Lead Annuity Trusts (CLATs) – An irrevocable trust which donates to charity for a set amount of time after which the balance is paid out to the beneficiaries. This structure may reduce the estate and gift taxes otherwise owed by the beneficiaries and may provide them with income tax deductions for charitable donations. This is the “polar opposite” of the charitable remainder trust.
- Qualified Personal Residence Trusts (QPRTs) – An irrevocable trust that allows the creator to remove a personal home from his or her estate for the purpose of reducing the taxes incurred when transferring assets to a beneficiary. The owner of the residence is allowed to remain living on the property for a period of time with “retained interest” in the house.
The type of trust you choose to utilize would depend heavily upon your unique circumstances, as discussed with your estate planning attorney. This is a task for experienced and well-trained experts, not generalist financial planners or financial advisors. However, advisors can often provide helpful referrals to qualified estate planning attorneys in your area and can provide helpful coordination concerning your overall financial circumstances.
Few elections years in history have matched the volatility and uncertainty of 2020. With election results officially in, don’t hesitate to reach out to your financial advisor to determine how your tax obligations may be affected, and what you can do now to prepare.
This content is developed from sources believed to be providing accurate information, and provided by Twenty Over Ten. It may not be used for the purpose of avoiding any federal tax penalties. Please consult legal or tax professionals for specific information regarding your individual situation. The opinions expressed and material provided are for general information, and should not be considered a solicitation for the purchase or sale of any security.