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President Biden plans to move forward with his proposed changes to our tax laws. If passed, the legislation will be the first major tax hike since 1993.
Recent Tax Law History
In 1993, President Bill Clinton signed The Tax Reform Act of 1993 into law which was aimed at reducing the federal deficit through increased taxes and reduced spending. The legislation led to significant changes in tax law for individuals and businesses. It was one of the first bills to retroactively raise taxes, effectively making the increases apply to taxpayer incomes from the beginning of the year.
In 2001 and 2003, during the George W. Bush administration, two temporary tax relief measures were enacted that lowered federal income tax rates for everyone, lowered the capital gains tax, and lowered the tax rate on dividend income. They also phased out personal exemptions for higher-income taxpayers and on itemized deductions. Additionally, new limits were placed on the estate tax.
The Bush tax relief measures, which were initially set to expire in 2008 and 2010, were extended by the Obama administration to 2012. Anticipating an increase in capital gains tax and the top marginal rate on ordinary income, many high income earners claimed as much income as they could on their returns in 2012 to avoid the following year’s increase. Congress wound up passing the American Taxpayer Relief Act of 2012 on January 1, 2013, which prevented most of the sunsetting tax cuts from expiring. Most of the 2001 and 2003 income tax cuts were made permanent for all but the highest-income taxpayers. The threshold was $400,000 for individuals and $450,000 for married couples. Incomes at and above the threshold were taxed at the Clinton-era 39.6% tax rate. Another change included a surtax of 3.8 percent on income from investments for the wealthy.
In 2017, President Trump signed the Tax Cuts and Jobs Act into law. This tax reform offered significant and permanent tax cuts to corporate profits, investment income, estate tax, and more. As it pertained to income tax, in most cases, it lowered the rates. The top rate fell from 39.6% to 37%, the 33% bracket to 32%, the 28% bracket to 24%, the 25% bracket to 22%, and the 15% bracket to 12%. The 10% and 35% brackets went unchanged. As for the estate tax, the exemption increased from $5.49 million to $11.18 million for individuals from $10.98 million to $22.36 million for married couples.
The Biden Administration
Since Joe Biden won the election in 2020, there has been a great deal of discussion around what new tax policies could be on the horizon. After all, Biden's tax policy greatly differs from his predecessor's. So, what should we be concerned with in the world of estate planning?
The federal estate tax exemption is currently $11.7 million per person or a combined $23.4 million per married couple. One potential change is to reduce the 11.7 million exemption to $5 million ($10 million per couple) or $3.5 million ($7 million per couple) and increasing the federal estate tax from 40% to as high as 70% on very large estates. These changes could be made retroactive to January 1, 2021, but is more likely to take effect on January 1, 2022.
Another potential change involves eliminating the step-up in basis at the time of death. Today, the deceased unrealized capital gains are not subject to the capital gains tax, and the beneficiaries of an estate receive a new step-up in basis equal to the market value at the time of death. Should the asset be real estate, the beneficiaries can take depreciation deductions based on this step-up in basis.
There is also discussion on making very technical changes to the estate tax laws, which would eliminate or reduce the effectiveness of certain estate tax reduction strategies. For instance, you could create an irrevocable trust (to allow you to make gifts to your children) and remain as the taxpayer of the irrevocable trust (these are called grantor trusts). These irrevocable trusts are not included as an asset in the deceased estate for estate tax purposes. One of the technical changes would be to change the tax law to say that if the deceased is the taxpayer of an irrevocable grantor trust, then the assets of the irrevocable grantor trust are subject to estate tax in the deceased estate - even though the deceased gave away the assets and had no control or access to the funds in the irrevocable grantor trust. Another technical change would be to limit the term of a generation-skipping trust or dynasty trust, so these assets are includable in the beneficiary’s estate (even though the trust has not terminated) when the beneficiary dies. A generation-skipping trust or dynasty trust could last for a long time, and there would never be an estate tax on the assets in the trust until the assets are distributed to the beneficiary, and the beneficiary then dies.
In addition, we are on the lookout for an increase in income tax rates for high earners. Wealthy Americans currently pay a 37% rate on wages and a lower 20% rate on investment earnings (plus a 3.8% surtax). Biden’s proposed plan would up the capital gains tax for millionaires to 39.6% — effectively taxing it as ordinary income.
According to President Biden, these tax increases are needed to raise revenue for the build-out of our nation’s infrastructure and to cover expenses from the recent 1.9 trillion-dollar COVID-19 Relief Package.
The Bottom Line
Change is inevitable which is why I have always said that estate planning is a process, not a product. Now is the time to review your tax and estate planning documents so you can take advantage of today’s exemptions and explore the gifting strategies available when and if these tax law changes take effect. Schedule an appointment with us today to discuss your options.