New Administration, New Estate Tax Complications: How to prepare clients for the big shift

New Estate Tax Complications: How to Prepare Clients for the Big Shift

As the U.S. gains a new president and a new majority in the legislative branch, proposed changes to the federal estate and gift tax will transform the way wealth passes from one generation to the next. For wealthier families, this means the loss of allowances they’ve benefited from under a looser estate tax regime.

As a financial advisor, the possible changes provide an excellent opportunity for you to deepen relationships with your clients. This quick guide will help you educate them on what to expect and offer guidance on how to navigate newer, more stringent estate tax regulations.

Changes in estate tax exemptions and rates

The most significant change will likely be a dramatic reduction in federal estate and gift tax exemptions.

Currently, individuals can transfer up to $11.7 million in assets (up from $11.58 in 2020) without having to pay estate or gift taxes. The generous allowance is thanks to the 2017 Tax Cuts and Jobs Act (TCJA) under President Donald Trump, which doubled the exemption threshold for wealthy individuals and left only 1,700 estates owing federal estate tax. This increased exemption amount is otherwise set to “sunset” (or expire) at the end of 2025 if Congress takes no action between now and then.

What will happen: President Biden plans to roll back the estate tax exemption from $11.7 million ($23,160,000 per married couple) to as low as $3.5 million ($7 million per married couple) in bequests at death and $1 million ($2 million per married couple) in lifetime gifts.

The Biden tax plan also proposes raising the estate and gift tax rate from 40% to 45%.

What this means: For many wealthy families, it means a steep tax bill when they transfer assets. For example, as estate planning attorneys Shearman and Sterling illustrate, if a client gives a family business worth $11 million to their children, they “would owe $4,500,000 in federal gift taxes” — almost half of the business’s value.

What to tell your clients: The Biden tax plan may be retroactive for the 2021 tax year once it passes Congress, but there’s a good chance clients can still transfer money under the current tax code. Reach out to clients who have estates between $3 million and $11 million individually (or $6 million and $22 million as a married couple) and revisit their goals for their estates and lifetime giving.

Changes in Grantor Retained Annuity Trusts (GRATs)

Democrats have introduced bills to lengthen the term of GRATs, eliminate loopholes, and require a minimum taxable gift.

Grantor Retained Annuity Trusts, or GRATs, are financial instruments that help minimize taxes on large gifts. The grantor uses up gift and estate tax exemption when they establish the trust (or otherwise pays a tax if there is no exemption left) but can avoid this using a technique called a zeroed-out GRAT. The trust pays out an annuity to the Grantor each year for a set amount of time, and so ends up receiving back assets valued to equal everything that was initially gifted. Since there is technically no gift, there is no tax. However, if the assets appreciate in value over the term of the Trust, that additional value can be transferred to others tax-free.

Currently, the minimum trust term is two years. The beneficiary can collect the remainder of the assets either outright or in a continuing trust without paying additional taxes, but only after the term expires. If the Grantor dies before the term expires, it’s basically like the Trust never existed from an estate tax planning standpoint.

What will happen: Congress could extend the minimum term of the GRAT to 10 years and eliminate the zeroed-out GRAT as a gifting technique. President-elect Biden’s plan will also require a minimum taxable gift, which is not required under current law.

What this means: The two-year GRAT term and zeroed-out technique is popular with wealthy clients because it made it possible for grantors to outlive the trust term and avoid paying taxes on large gifts without using any of their gift and estate tax exemption to fund the initial gift. By extending the minimum term and closing loopholes, it’s less likely that grantors will outlive the term of the trust, and their children and beneficiaries will receive a smaller portion of the remainder of the assets.

What to tell your clients: If your clients currently have large gifts as a part of their estate plan, it’s recommended that they talk with an estate planning attorney to discuss lifetime gifting techniques.

Changes in capital gains taxes

Biden has proposed two major changes: 1) closing a loophole that lets some people avoid paying capital gains taxes and 2) increasing the top federal tax rate on long-term capital gains and qualified dividends.

According to Alica Cole at Plante Moran Wealth Management, “Currently, when a taxpayer dies, the assets in his or her estate receive a basis adjustment to fair market value as of the date of death, meaning that heirs may sell assets without realizing a capital gain.” (This assumes that the sale price of the asset after death is equal to the fair market value adjustment).

What will happen: Biden proposes to eliminate the “step-up in basis” loophole that enables heirs to avoid paying capital gains taxes. Biden also proposes increasing the tax rate on capital gains and qualified dividends from 20% to 39.6% on income above $1,000,000.

What this means: When your clients leave behind large investment assets (real estate, stocks), long-term capital gains will take a bigger chunk out of their heirs’ inheritance.

Let’s say a client wants their children to inherit a house they bought many years ago for $50,000. In today’s market, the house is worth $2 million.

Under the current basis rules, if heirs eventually decide to sell the home, they would just owe capital gains tax on the appreciation the house earned after the time of inheritance. If they sell the home immediately upon the client’s death, there would be no capital gains tax owed.

Under the Biden tax plan, a capital gains tax on the entire appreciation of the house would be due upon the client’s death based on the original $50,000 basis of the house.

What to tell your clients: Work with your clients to determine how to get the most value out of their assets now and help beneficiaries avoid unnecessary tax burdens after death.

Make it easy to adapt to new estate tax changes with Vanilla

The more you anticipate your clients’ needs and help them overcome challenges, the stronger and longer-lasting your relationship will be. Vanilla’s estate reporting tool helps you show clients their current plan, so you can help them make changes and protect their assets. Download a sample report below.

Help your clients stay up-to-date with major changes in law

This article is for educational purposes only and should not be considered legal advice. If you feel that the information in this article is pertinent to your situation, you may wish to consult a qualified attorney for advice tailored to your circumstances.

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