Although the estate and gift tax exemption for 2020 is $11.58 million per person (resulting in a married couple’s ability to pass $23.16 million tax-free), this is only temporary. The exemption will automatically revert to $5 million (adjusted for inflation) in 2026 if Congress doesn’t make any changes before then.
The likelihood that no changes will be made by then are slim, since President-Elect Biden has proposed significant changes in the tax laws, including a possible reduction of the exemption to $3.5 million per person.
While there is no way to know now precisely what revisions will be enacted (especially since it’s not yet clear which party will control the Senate), it is a good idea for you to make “annual exclusion” gifts before year end. These gifts do not count toward your exemption and can be up to $15,000 per person per year ($30,000 if your spouse joins in the gift).
Another reason to consider year-end gifting is that, in addition to the federal estate tax, nearly half the states have a state estate or inheritance tax. For example, in Oregon, the exemption from estate tax is only $1,000,000, and in Washington, it is $2,193,000.
If you’re in a position to do so, you should consider making much larger gifts. This is because the Treasury Department issued regulations stating that there will not be a “clawback” if you make a gift now and the exemption is reduced in 2026 as currently scheduled.
Unfortunately, the regulations do not address what will happen if the exemption is reduced prior to 2026, but many commentators believe that the result will be the same.
Another part of the Biden tax plan is the removal of the step-up tax basis. Under current law, your heirs receive the tax benefit of a step-up in basis. Many assets passed down through your estate will have gained in value between the date you purchased them and the date of your death.
This gain in value would ordinarily result in a capital gain, meaning that when appreciated assets are sold, the seller may owe capital gains taxes on the appreciation. The amount of the gain is generally the sales price minus the “basis,” which is usually the original purchase price.
But when the assets are acquired through inheritance, there is a step-up in basis, so that an heir’s basis is the present fair market value instead of the original purchase price.
For example, Mary bought shares of stock for $5,000 many years ago and those shares are now worth $1 million. If she sells those shares, she’ll owe capital gains tax on $995,000.
If, however, she passes away and leaves the shares to her son Joe, who immediately sells the stock for $1 million, he won’t owe any capital gains tax. This is because Joe’s basis is $1 million – despite the fact that Mary’s basis was only $5,000.
Under Biden’s proposals, Joe will have the same basis in the stock that his mother did – $5,000, so even if he immediately sells the stock for $1 million as in the scenario above, he’ll owe capital gains on $995,000.
Please feel free to contact us if you have any questions about the above or if you need help with your gift and estate planning.
You may also be interested in obtaining a copy of Estate Planning (in Plain English)®, written by members of this law firm and available through Amazon, Barnes and Noble, and Bookshop (an online bookstore that allows you to support your favorite independently owned bookshop.)
Photo by freestocks on Unsplash
