Now that the Georgia runoff elections are behind us, the stage is set: Joe Biden will be the President of the United States, Democrats will control the House, and a 50-50 split in the Senate favors Democrats since Vice President-elect Kalama Harris holds the tiebreaking vote. What might this mean for future tax reform?
New Administration and Congress: President-elect Biden and many Democrats campaigned on reforming the current tax regime, including changing income tax rules and aspects of wealth transfers. While the recent election results increase the odds of passing key Democrat proposals, quick and sweeping tax reform appears unlikely. A 50-50 split in the Senate makes it difficult to implement some of the more progressive proposals from Democrats, as just one Democrat Senator could pose a roadblock. Such proposals include:
- Reducing the federal estate and gift tax exemption from $11.7 Million to $5 Million (or potentially $3.5 Million) before the scheduled sunset on January 1, 2026 (as discussed below). Some commentators suggest that an accelerated reduction might be applied retroactively to January 1, 2021.
- Increasing the estate tax rate, which is currently a 40 percent rate.
- Eliminating the automatic adjustment of income tax basis of assets to the fair market value at death, which often erases any capital gain on appreciated assets owned by a decedent.
2021 Exemptions and Exclusions: The IRS has announced that the estate and gift tax exemption amount will increase from $11.58 Million per person to $11.7 Million per person in 2021. The 2021 generation-skipping transfer tax (GST tax) exemption amount will also increase to $11.7 Million per person. However, even if no action is taken by the incoming Biden Administration and Democrat-controlled Congress, current law provides that these heightened exemption amounts will revert to $5 Million per person (as upwardly adjusted for inflation) on January 1, 2026. Projections show that the exemption would be approximately $6.5 Million per person at that time.
Every year, each person is allowed to make a gift to another person up to a certain amount without incurring any gift tax liability – this is known as the “annual exclusion.” The annual exclusion is a powerful tax-saving tool because the person making the gift can transfer wealth without using any of his or her estate and gift exemption amount. The annual exclusion for 2021 will remain at $15,000 per donor, and this amount is per donee (so, for instance, a child can receive $15,000 from each parent without incurring any gift tax liability). Married couples can gift up to $30,000 to each donee in 2021 without utilizing their estate or gift tax exemptions.
January Interest 2021 Rates: Continuing with the trend of record-low interest rates, the IRS recently released adjusted applicable federal rates (AFRs) for January 2021. The short-term (under three years) is 0.14 percent, mid-term (three to nine years) is 0.52 percent, and long-term (more than nine years) is 1.35 percent.
Regardless of the recent election outcomes, current factors, like depreciated asset values as a result of the COVID-19 pandemic, record-low interest rates, and historically high estate and gift exemption amounts, provide unique opportunities to minimize your tax exposure. In a previous Client Alert, which can be found here (Planning with Low Interest Rates and Temporarily Reduced Asset Values) we discussed several tax-efficient strategies to consider, including: intra-family loans; Grantor Retained Annuity Trusts; sales to Intentionally Defective Grantor Trusts; and Charitable Lead Annuity Trusts. In addition, taking advantage of the higher exemption amounts now, particularly for single individuals with an anticipated gross estate in excess of $3.5 Million and married couples with a combined anticipated gross estate in excess of $7 Million, should also be considered.
As we flip our calendars to 2021, let’s start the conversation about tax-saving estate planning techniques that are available to you. Please contact one of Michael Best’s Wealth Planning attorneys to explore planning opportunities.