By: Eric Miller
As with every election year, there is a great deal of uncertainty of what to expect. Taxes are always a popular topic amongst the candidates regardless of the year, and that trend has continued for the 2020 election. When discussing taxes the popular area that is addressed are Income Taxes and an area that can sometimes be overlooked can be the Gift and Estate Tax.
The 2018 tax reform brought with it significant changes to the Gift and Estate Tax, increasing the federal exemptions from 5.49 million to 11.18 million. When this happened, many taxpayers believed they no longer needed to worry about any sort of major gifting or estate planning as their estate was under 11 million, or 22 million if married. However, a change in the presidency or a shift in control in the House or Senate could change these rules. With the possibility that these exemptions could decrease to 2012 levels or even pre-2012 levels means that taxpayer’s need to evaluate their current financial position, future plans, and prepare for the future to not miss out on being able to protect large amounts of their hard earned wealth from estate taxes.
If Trump is re-elected or the Republicans maintain control, there is the possibilities that the current rules are kept in place through 2025, as originally set under the 2018 reform. There is even the possibility of making the current exemptions permanent and not subject to sunset in 2025. If no action is taken, the exemptions are set to decrease to pre-2018 levels of 5 million.
If Biden is elected or if the Democrats gain control, the rumored changes to the current exemptions could be drastic. Not only is there a chance that the exemption amount could drop to the 2012 exemption amount of 5 million, there is a chance it could go to the 2009 amount of 3.5 million. The fact that the exemption amounts could decrease so much is scary enough on its own but the potential changes do not stop there. There is also the possibility that the stepped-up basis may be removed, meaning that the taxpayer’s original cost basis will be passed to the beneficiaries of an estate even after estate taxes have been paid on the fair market value of the asset. For many assets, this can lead to massive amounts of taxes paid for both estate taxes and future income taxes by the beneficiaries. And if that weren’t enough, the tax rate could be changed. The current Estate and Gift Tax rate is 40%. This was 45% in 2009 and has been as high as 55%.
Additionally, some of the more popular estate planning vehicles, such as Grantor Retained Annuity Trusts (GRATs), Generation Skipping Trusts, and Grantor trusts might be targeted and changed. A very popular technique that has been used is to make a gift of an asset to a Grantor trust that removes the asset from the taxpayer’s estate but requires the taxpayer to then continue reporting the income generated by the trust on their personally filed income tax return. Doing this allows for the Grantor trust to not have to use any of its own assets to pay income taxes as the taxpayer pays it on behalf of the trust and does not need to incur any additional gift tax. This helps the trust to continue growing, not needing to spend any of its own earnings on taxes, while it further helps to reduce the estate of the taxpayer.
Another important item to note is that if there is a change in the gift tax exemption, gifts are made from a bottom up approach, not a top down. What this means is that if a taxpayer makes a gift of $4 million in 2020 when the exemption is $11 million, there will be $7 million of gift and estate exemption remaining. If in 2021 the exemption is reduced to $5 million, the taxpayer will still have used up $4 million of their exemption while only have $1 million remaining.
One item that will need to be considered and planned for if making large gifts will be the state of residency. Connecticut for example has its own separate gift tax. While this amount has been increasing each year since 2018, up from $2 million, the 2020 exemption is only at $5.1 million. This means that any federal gift in excess of $5.1 million, assuming no exemption has been used, will be subject to Connecticut gift taxes. Connecticut also has its own set of unique rules when calculating its gift tax as if any exemption has been used already, it is not a dollar for dollar increase. A calculation will need to be done to see how much Connecticut gift tax is still available.
While New York does not have its own gift tax like Connecticut, it does present its own items to consider when making gifts. New York has a “claw back” period of three years. This means that any gifts made within three years of the date of death are brought back into the taxpayer’s estate for New York purposes.
It is very unlikely that any sort of change, if they were to occur, would happen right away in 2021. Even with that thought, one should not gain a potential false sense of security that any gifts done before any changes are made are safe. There can always be the possibility that a change can be made retroactively. This would mean even though a change occurred in July of 2021, gifts made in January 2021 when the then old rules are still in place, could now be subject to the new rules.
While the above items are not guaranteed, the possible changes that could occur are drastic enough that taxpayer’s should be considering all of their options. While taxpayer’s can wait to see how the election plays out and will have until December 31 to execute any plans, the planning can start now. What is your overall goal? Do you want to make sure you have just enough and leave everything to the next generation? What assets do you have available to use? Depending on the answers to these sorts of questions, the manner of gifting will be different, as well as seeing whether or not it is worth doing this gifting. Everyone’s situation is a little different, and as such everyone needs to look at their own estate and plan differently.
Additionally, your accountant and attorney will greatly appreciate discussing these items while there is more time to determine the best course of action.
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