Estate Planning in an Uncertain Time

As seen in the Westchester & Fairfield County Business Journal

The inauguration festivities have wrapped up and Joseph R. Biden Jr. is the 46th president of the United States. Democrats now control both the House and the Senate but what’s next? Sweeping tax changes have been widely discussed but it is still too soon to know what will happen for sure. Due to the current pandemic, it may take us a bit longer to see any tax law changes come to fruition, but one thing is certain, planning is as important as it has ever been.

Tax professionals have long been accustomed to being their clients’ trusted advisors for planning, especially in times of tax law change. When the Tax Cuts and Jobs Act (TCJA) passed back in 2017, the estate tax exemption increased to over $11 million, and now stands at $11.70 million in 2021. For most, this made estate planning easier but certainly not obsolete. Set to sunset in 2025 and return to $5 million, many tax professionals took a proactive approach to estate planning during the past few years. With a new administration in office, tax and estate planning professionals are key to staying ahead of what may be coming.

It is important to understand that no tax law changes have been officially proposed and we only know what has been touted during the campaign. However, one concern in particular is that the estate exemption level could drop to $5 million, or even lower to $3.5 million. This in itself presents a plethora of estate planning opportunities. Many more people may now be interested due to the potential decrease in the exemption. Some have expressed concern that if they gift up to $11.7 million and then pass away after the exemption reverts back to $5 million, that they will owe estate tax on $5.7 million, in addition to whatever assets are still in their estate. The Treasury has provided guidance and has stated that they are not going to claw back gifts made prior to 2021, which allowed taxpayers to decrease their Federal estate by transferring assets now and drawing the appreciation out of their estate. If the exemption goes down in 2021, it may be retroactive to January 1st meaning that gifts made in excess of the reduced exemption would be taxable in tax year 2021. Gifts made in 2021 would provide a surprise tax bill. For example, if someone gifted $5 million and the exemption goes down to $3.5 million, the taxpayer would owe gift tax on the difference.

In addition, there is the potential loss of stepped-up basis. What is a “step-up basis” you may ask? This refers to a provision in the current law that states that the value of an asset is determined at date of death, not its original cost. For example, if you inherit stock worth $500,000 that your parent purchased for $200,000, your new tax basis in the shares would be $500,000 not $200,000. The increase of $300,000 is the stepped up amount. If you sell the shares for $600,000 in the future, you will recognize a $100,000 gain ($600k less $500k), not a $400,000 gain due to the step-up in basis. With the potential increase of capital gains tax, this makes the loss of step-up in basis even more critical. It is important to work with your tax professional at this time and communicate what your goals are. Just as a bespoke tailor makes a custom tailored suit, tax professionals have the ability to make each plan unique to the client. There are a multitude of ways to get assets out of your estate so your heirs do not have to pay a potential 40% in Federal estate tax in addition to state estate tax. Between various gifting strategies, trusts, and charitable bequests, tax professionals can provide a unique blueprint to navigate you to the right place.

While some are concerned about federal regulations, each state has its own regulations as well. Taxpayers in Connecticut should be aware that the Connecticut gift and estate tax exemption for 2021 is only $7.1 million and transfers in excess will create a Connecticut estate tax. Meanwhile, taxpayers in New York may already know that there is no gift tax in New York but gifts made within three years of death are added back into a taxpayer’s New York taxable estate. In addition, New Yorkers have an estate filing requirement on estates over $5.93 million. However, once the estate is over 5% more than $5.93 million ($6,226,500) the tax is calculated on the first dollar at graduated rates up to 16%.

Many might agree that making a big financial decision is difficult. Making a big financial decision when you do not have all the facts is even more complicated. During this time when much is unknown, it is important to be proactive. In a time of great uncertainty, one thing you can be certain of is that just having that first conversation with your tax professional will lay the foundation to achieving your financial goals.