Earlier this year, two respected estate and business planning organizations, WealthCounsel and Trusts & Estates magazine, surveyed over 500 estate planning professionals to see what opportunities and challenges their clients face. The results from the survey indicate there are concerns that proposed legislation could have wide-ranging implications if passed. Below are the top four concerns people have regarding estate planning and business planning that the survey revealed.
Concern #1 – Income taxes will increase
Over 70% of respondent attorneys said a major concern among their clients is the potential increase in income taxes. These fears likely came about after President Biden’s administration shared its American Families Plan, which would increase the income tax rate for the top one percent of taxpayers—from 37% to 39.6%—affecting taxpayers with annual incomes over $400,000.
What are ways to alleviate the income tax increase concerns regardless of your tax bracket?
There are income reduction benefits when you contribute to an individual retirement account (IRA) or 401(k) plan, where taxes are deferred until you withdraw funds during retirement. Considering the time value of money and the likelihood you will be in a lower tax bracket in retirement, the income tax savings may be substantial. If you expect a higher tax rate during your retirement, consider converting existing retirement accounts into a Roth IRA account.
Consider gifting income-producing assets. By shifting income-producing assets to beneficiaries, you will reduce not only your taxable income but also the size of your estate for estate tax purposes. Besides a possible increase in ordinary income tax rates, there may also be an end to the preferential treatment of long-term capital gain on investment property. Business owners and others with appreciated assets may wish to recognize long-term capital gain now under the more beneficial tax rates. For the charitably inclined taxpayer, charitable giving can prove an effective way to reduce income taxes and simultaneously help a worthy charity.
Concern #2 – The estate tax exemption amount will decrease
The good news: Florida does not have a state-level estate or gift tax. That cannot be changed unless a super majority of voters vote to impose those taxes, which is highly unlikely. The not-so-good news: the federal government does have an estate tax. However, the federal estate tax exemption amount is at a historical high ($11.7 million for individuals and $23.4 million for couples with proper planning), which means federal estate tax affects less than 1% of the U.S. population. This high exemption amount is unlikely to last long. Unless Congress acts, the exemption amount will end on January 1, 2026, and revert to $5 million. We might see the amount decrease before that date, as the Biden administration has suggested it would support reducing the estate and gift tax exemption to $3.5 million (or $7 million per married couple with proper planning). If the federal estate tax exemption amount is reduced, it will affect a much larger percentage of our population.
What can you do to alleviate the concern about a lower estate tax exemption?
When you update your estate plan in 2022, planning for a lower federal estate tax exemption amount should be considered. The Tax Cuts and Jobs Act of 2017 doubled the estate and gift tax exclusion amounts for 2018 through 2025. The thinking is that high net worth individuals should lock into the higher exclusion amounts by completing gifts before the exclusion amounts are reduced either in 2026 or by earlier action of Congress. Clients should not only consider taking advantage of the annual gift tax exclusion ($15,000 for 2021) but also complete gifts either outright to beneficiaries or to irrevocable trusts. By utilizing irrevocable trusts such as a spousal lifetime access trust, clients could continue to indirectly benefit from the trust if the client needs funds.
For clients with a comfortable amount of assets who do not wish to increase the size of their taxable estate, they may want to consider a grantor retained annuity trust (GRAT), specifically a zeroed-out GRAT, which would allow the client to transfer the appreciation on investments without having to use gift tax exemptions.
Concern #3 – The stepped-up basis at death regarding capital gain tax will be eliminated
An asset’s value on the day the owner dies determines its tax basis, effectively eliminating income tax on any appreciation that occurred during the owner’s lifetime and requiring the owner’s beneficiaries to pay income tax on only the appreciation that occurs after the death.
However, proposals from the Biden administration would eliminate the step up in tax basis at death for gains of more than $1 million on inherited assets ($2 million if inheriting from a married couple). This could require beneficiaries to pay additional tax when they sell the inherited asset. Or, the gain could be realized when the asset is inherited, creating an immediate tax liability. With the Millennial and Gen X generations standing to inherit $30 trillion in the coming decades, this change could have far-reaching implications.
What can you do to alleviate the concern about the step up in tax basis being eliminated?
Eliminating the step up in tax basis at death and the preferential treatment to long-term capital gain tax would be a double whammy. Review your appreciated assets to determine whether it makes sense to recognize gain now or, upon death, pass the gain to your beneficiaries who will pay the tax on any gain. Gifting assets before they appreciate can help alleviate the loss of the benefit of the step up in basis at death.
Congress is not expected to apply tax changes retroactively to apply to the 2021 calendar year. Before making any hasty moves, review your entire estate plan with your attorney and tax advisor to analyze how the elimination of the step up in basis may affect your assets.
Concern #4 – Federal estate tax rates will increase
According to the Industry Trends survey, 57% of attorneys report their clients are concerned with increased estate tax rates. Under the current laws, the top estate tax rate is 40%, but the Biden administration has proposed increasing the estate tax rate.
Not only would the new tax proposals drop the exemption down to $3.5 million (transfer at death) and $1 million (for lifetime gifts), the proposals would increase the tax rates for gifts, estates, and generation-skipping transfers from the current rate of 40% to as high as 65%.
What can you do to if federal estate tax rates increase?
Discuss with your attorney whether a zeroed-out GRAT to freeze estate values would be helpful for your family, and consider an irrevocable grantor trust. Funding an irrevocable trust reduces your estate’s size. The best way to avoid an increased estate tax rate is by reducing your taxable estate.
If you have an ultra-high net worth estate, discuss with your attorney whether you should take advantage of gifting with a family limited partnership or a sale to an intentionally defective grantor trust. This so-called “discount gifting” is a powerful way to reduce the size of a taxable estate.
With the New Year approaching, this is a good time to schedule a discussion with your estate and business planning attorney. Do yourself and your family a favor and review the above concerns and any other concerns with your attorney.
You may contact our office at (813) 852-6500. We would be pleased to hear from you to make an appointment in 2022 to discuss what you may do to alleviate your concerns about estate planning and business planning.