2020 has been an interesting year for many reasons. As we approach year-end, we recommend doing a number of things from an estate and gift tax-planning standpoint. Those ideas are discussed below. However, with 2020 being a presidential election year, a significant planning opportunity might exist this year that otherwise may not occur again.
For 2020, the estate, gift and generation-skipping-tax exemption is set at $11.58 million per person and is scheduled to increase each year by a cost-of-living factor. However, that level of exemption is due to sunset after 2025, when it would return to half that amount. The $5 million level of exemption (adjusted annually by a cost-of-living adjustment or COLA) came into the law in 2011. Prior to then, the exemption level had reached $3.5 million.
The estate tax law also allows an adjustment in basis to the date of death fair market value when one passes away. We normally think of this as a step-up in basis, since, most of the time, assets have increased in value from the time of purchase. This has been the law for many years.
In this presidential election year, Democratic presidential nominee Joe Biden proposes, among other things, to “return the exemption levels to historic norms” and “eliminate the step-up in basis for inherited assets.” Whether historic exemption levels mean the $5 million level referred to above or the pre-2011 $3.5 million level is unclear.
Of course, the changes that Biden proposes would be possible only if he wins the presidency, and the Democrats take the Senate and retain majority in the House. In January 2021, new legislation could be introduced to effect these changes. New law could possibly be effective retroactively to Jan. 1, 2020.
The next few months may be the last time individuals will have an exemption of $11.58 million. If it is used to shelter gifts in 2020, the use would likely be grandfathered even if the exemption level is reduced in the future. In this scenario, the use is the “excess” of the current level over what it might be reduced to, to be considered “used.” For example, gifts of $9 million in 2020 will use $4 of the “excess” over the $5 million level if the law is changed to reduce the exemption to $5 million. If gifts of only $5 million are made in 2020 and the exemption level is reduced to $5 million, the opportunity to use the “excess” will have been lost.
Clients with the wealth to take advantage of this historically high exemption level have many ways to make gifts in 2020. While this article will not be able to discuss all the options in detail, there are ways to make gifts that are straightforward. Of course, there are also more complicated techniques requiring time and planning — and time is quickly running out to do so before year-end. The following strategies should be discussed with your estate planning advisors.
Finally, taxpayers who have already engaged in significant transfer planning in recent years (in response to earlier tax law changes) may have significant promissory notes still outstanding from earlier sales to grantor trusts. Those promissory notes, or some portion of them, can be forgiven by Dec. 31, 2020, to use the excess exemption.
Comparing the current income tax rates to estate and gift tax rates, the income tax basis of the assets used to make gifts is now more important than before. Gifting higher basis assets is more beneficial than lower basis assets because of the current step-up in basis that can occur on death with lower basis assets included in the estate. Basis needs to be considered in any gift strategy. However, transactions with grantor trusts may continue to give the donor flexibility to address this issue. In addition, if business assets are used in a succession planning situation, consider whether that asset will be sold in future generations when discussing the impact of basis. Finally, the possible elimination of the step-up in basis rules would change our thinking again on all transfers. Please consult your estate tax advisor before deciding which assets to gift.
Finally, there are states with their own estate tax regimes and those states usually do not have the same federal exemption level of $11.58 million. Only one state has a gift tax for lifetime gifts. Planning needs to also factor in the impact of lifetime giving in excess of those state exemptions. As long as the state does not require you to include those prior gifts in the state’s taxable estate calculation, you can move more asset value to heirs during lifetime with gifts than if you wait until death to transfer those assets. Again, consult your estate tax advisor.
For more information on this topic, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.