Recently, the Biden Administration introduced the American
Families Plan, which, among other things, proposes a series of increases in
individual tax rates to pay for a massive new spending measure supporting
childcare, paid family leave and education. While the American Families Plan is
still a proposal and many specifics are scarce, along with other proposals
being floated, the following can be helpful for client estate, tax and
financial planning conversations in the meantime.
Elimination Of The Basis Step-up At Death: The
step-up in basis would cease for gains above $1 million. This seeks to
eliminate a popular estate planning tool where assets are stepped up to the
date of death value upon death. The desire to eliminate the step-up in basis is
not new. Its elimination has been discussed for the past decade. However, removing
it may be more challenging than it seems. The intent of the step-up in basis is
grounded in administrative convenience because it is very difficult to
determine the basis on assets held for decades, not to mention tracking
depreciation and add-backs. As a result, recalibrating the cost basis at
someone's death is infinitely easier to determine. For this reason alone, the
step-up continues to survive year-over-year and may survive this challenge too.
Capital Gain Realization At Death: A new Senate
bill—the Sensible Taxation and Equity Promotion Act (STEP)—would trigger the
realization of long-term capital gains on lifetime transfers and at death.
There would be an exception for the first $100,000 of gain for lifetime
transfers, and at death, there would be an exclusion for the first $1 million
of gain. There are also exclusions for farms and closely held businesses.
This may be worse than eliminating the step-up because it
would force the realization of gains even if assets are not sold, but merely
transferred. This would have a similar effect to the estate tax by triggering
tax even if there is no immediate liquidity. If it passes, planning for
liquidity for lifetime and death transfers will become a prime planning
Reduction Of Estate And Gift Tax Exemption: The
current proposal does not address a change to the estate tax exemption amount,
although reducing the exemption was part of Biden's campaign. While this is a
significant relief for many, a bill introduced in the Senate—the 99.5%
Act—proposes decreasing the gift tax to $1 million and the estate tax to $3.5
million. Again, it's important to note that this could change as the bill works
through Congress and it is not law. As a result, at least for now, we can
breathe a sigh of relief that the estate tax is not on the chopping block until
Enactment Date: The American Families Plan is still a
proposal. Before we see anything become law, we're likely to see extensive
negotiations and a process that could take months to work its way through
In the meantime, the proposals are silent on an effective
date. While tax law changes are typically prospective, there’s significant talk
about these changes being retroactive. A revision of the 2021 budget is
possible, which means changes to the tax law could go into effect in 2021. Why
is this? The Senate parliamentarian determined another revision of the 2021
budget is possible this year. Through reconciliation, this could include
implementing both the American Jobs Plan and the American Families Plan through
a simple majority vote, rather than requiring sixty votes (similar to how the
Tax Cuts and Jobs Act (TCJA) was passed in late 2017).
However, due to the impact on these tax law changes,
significant negotiations are likely to occur, even amongst Democrats, which
means it could be later in the year or even into early 2022 before we have
clarity. Alternatively, the changes could be passed in an end-of-year budget
bill—reminiscent of the SECURE Act in December 2019.
Planning For Uncertainty
These proposed changes are significant, and clients and
their advisors should not be complacent if they have a scenario where acting
today is advantageous. Reviewing options today will help them be prepared to
act when a law is actually passed.
Increase In Capital Gains:
1. Harvesting Gains: Capital gains today are the
lowest they have ever been. Therefore, if capital gains rates are set to
increase, it may be best to sell some winners to lock in a lower tax rate
today. In the right circumstance, this could result in a lower tax bill and the
opportunity to rebalance a portfolio into more tax-efficient investments.
2. Tax-loss harvesting: Since the proposed higher tax
rates are for those with income over $1 million, initiating plans to keep
income below $1 million will be key. Therefore, it would be advantageous to
strategically capture losses to offset future gains, especially if they can
keep net income below the magic $1 million threshold.
3. Charitable Giving: Similar to tax-loss harvesting,
strategically giving to charity would help drive down net income, which could
help keep clients out of the top marginal bracket and prevent the realization
of gains in this top bracket too.
4. Capital Gains Bunching: Like bunching for
charitable giving, this involves strategically selling assets so that total net
gain realized is close to but below a $1 million tax threshold. By doing this,
a client would not trigger a higher 39.6% tax rate. This strategy could be
facilitated year-over-year to minimize taxes.
5. Hold assets longer: The tax code is constantly
evolving. Those who do not intend to realize any significant gains in the
coming years could wait to see what happens under a future administration. Just
as the current administration desires to implement these tax changes and unwind
the TCJA, we could see the same happen for the American Families Plan under a
future administration. Of course, this is a big unknown, but deferring the
realization of gains may be at least a partial strategy worth considering if it
works out for a client's situation.
Changes To The Step-Up And Realization Of Capital Gains
If the step-up is eliminated, gifting assets during life
becomes much more appealing because it removes future growth from a client’s
estate. The best options are those that create flexibility and liquidity, which
include the following:
• Grantor trusts allowing for post-execution planning—such
as swapping assets, borrowing, and loaning.
• Irrevocable trusts that create flexibility for gifting to
• Spousal lifetime access trusts allowing spouses to
irrevocably gift assets to each other, which uses the temporarily high gift tax
exemption amounts today while also giving each spouse indirect access to the
assets through their spouse.
• Life insurance held in an irrevocable trust creates
liquidity for paying taxes and is income tax-free at death, while also
remaining outside an estate for tax purposes.
• Gifting low-basis assets to charity or within a charitable
remainder trust (CRT) allowing for removal from the estate and creating a tax
deduction (can be used to diversify from concentrated positions). The CRT also
creates an income stream for life or up to 20-years.
• Valuation discounts that leverage gifting above the estate
tax exemption amount.
While none of the above strategies is a silver bullet by
itself, using them in some combination could result in benefits for clients.
Ultimately, none of the proposals are law and any that become law will
undoubtably look different in their final form. As a result, no strategy should
be implemented without significant discussion and planning. However, planning
ahead will be critical because all of the above strategies take time to design
and implement. As noted, we could see these proposed tax law changes
implemented in an end-of-year budget plan, which would leave little time to
implement strategies from scratch.
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