If President Biden’s tax proposals go into effect, they will
have an enormous effect not only on the way business owners run their companies,
but also how they plan their estates.
Currently, a married couple can pass tax-free an unlimited
amount to each other, either during life or at death. Each person’s estate also
has a tax credit that allows a spouse to pass $11.7 million to a non-spouse. Moreover, the unused portion of the tax
credit of the deceased spouse is “portable” to the survivor. This means that a
married couple, in a properly structured estate can pass $23.4 million to
children, an amount more than enough to shelter most small businesses from an
Uncle Sam tax grab.
However, the Biden administration has announced it wants to
lower a tax-free estate to $3 million. (It is not clear whether unused
deductions will be portable.)
The White House has also announced that it intends to raise
the tax rate from 40% to 45%. The impact on a family business could be
devastating. Assume a couple’s business
and other assets total $6 million, owned 50-50 between them. Assume the man
dies first with a simple will leaving everything to the wife. Assume no
Her estate would then be $6 million with a deduction of $3
million, leaving a taxable estate of the same amount, and a tax bill of
$3,000,000 x 45% = $1,350,000. And the
I.R.S. wants its money in nine months. The trick is making sure the available
tax credit is used in each spouse’s estate so the tax credit available to the
first spouse to die is not wasted.
One way to do this is to use a “disclaimer trust” strategy
where on the death of the first spouse everything is “offered” to the survivor.
If the tax rules in place at the time allow the survivor to
receive the assets of the deceased spouse without causing a tax problem, he/she
would simply accept them.
Where receiving assets from the deceased spouse would create
tax exposure, they might be “disclaimed,” or not accepted. The deceased
spouse’s estate would then use its $3 million deduction and no death tax would
The disclaimed money would then drop into a special
sub-trust called the “by pass trust”– of which the surviving spouse is the
beneficiary, with assets passing tax-free to children someday.
A second area of concern is that the president wants to do
away with the “step-up” in tax basis on death.
An example: If I give you IBM
stock that I bought 50 years ago for $10 a share, and you sell it 10 years
later for $110 a share, you deduct from the sale price what I paid for it (the
donor’s “tax basis”) and pay a long-term capital gains tax on the $100
However, if you get the stock from my estate, the tax basis
“steps up” to the fair market value at my passing. If that value is $110 and
you immediately sell the stock for that amount, you pay zero taxes. Loss of
basis step-up is bad enough, but Biden also aims to essentially double the
capital gains tax rate.
His plan is a quadruple whammy: Reduction in the tax-free
estate amount, increase in the death tax rate, doubling of the capital gains
rate and loss of step-up in basis. Too
many children of business owners will find themselves having to sell the family
business to pay taxes.
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