Estate Tax Increases: Protecting Your Slice of the Pie

Nov 25, 2020 | Tax Season

The 2020 election changed the balance of power in Washington. Even with the specifics of the new tax plan still being hammered out and control of the senate not yet determined, estate tax reform is looking increasingly likely.

The changes expected under a Biden administration include reductions to the Estate and Gift Tax Exemption and the elimination of basis step-up at death.

Here’s what those changes mean for your estate planning, and what you should do now. 

Change is Coming

The current Estate and Gift Tax Exemption for individuals is 11.58M per taxpayer. Transfers over that exemption amount are subject to gift or estate tax at a rate of up to 40%. 

Biden has proposed a significant reduction to this exemption and a tax of 45% on any additional gifts. Any remaining gift tax exemption not used before the end of the calendar year will be forfeit. Additional gifts will be taxed at the higher rate.

The second major proposed change is the elimination of basis step-up at death. 

Currently, the basis of inherited property is “stepped-up” to the property’s fair market value on the deceased’s date of death. This process eliminates all capital gains on appreciation between the time the asset was acquired by the deceased and their date of death. Biden has endorsed eliminating this benefit, which significantly increases the taxes owed.

So what should you do? Here are a few options to reduce the tax burden for your heirs. 

Make Interest Rates Work For You

Federal interest rates are currently extremely low, so donors can loan funds or sell income-producing assets to family members for a note charging interest at the federal rate. Because of the low rates, the loaned funds can produce a return rate that exceeds the interest rate. This policy lets the donor transfer wealth without using the estate or gift tax exemption. 

A similar approach involves setting up an irrevocable trust. Under this strategy, the difference is that income-producing assets are sold to an irrevocable trust instead of directly to a family member. Donors can pass appreciation to their beneficiaries with limited estate and gift tax implications. It also helps donors maximize their remaining gift and generation-skipping transfer tax exemptions.

Gift Now

Another option is to gift before the end of the year. A spousal lifetime access trust (SLAT) allows donors to lock in the current, historic high exemption amounts and avoid adverse estate tax consequences upon death. 

The donor transfers an amount up to the donor’s available gift tax exemption into the SLAT. Because the gift tax exemption is used, the value of the SLAT’s assets is excluded from the gross estates of both the donor and the donor’s spouse. The donor’s spouse may also execute a similar, but not identical, SLAT for the donor’s benefit.

Because the SLAT provides protection against both federal estate taxation and creditor claims, it is a powerful wealth transfer vehicle that can transfer wealth to multiple generations of beneficiaries.

Use Life Insurance 

Another way to minimize tax liability is to transfer an existing insurance policy into an irrevocable life insurance trust (ILIT). Gifts to the ILIT qualify for the annual gift tax exclusion, and the trustee uses those gifts to pay the policy premiums. Since the insurance policy is held by the ILIT, the premium payments and the full death benefit aren’t included in the donor’s taxable estate, and the insurance proceeds at the donor’s death will be exempt from income taxes. 

Consult an Estate Planning Attorney

A new tax plan would go into effect after the new year, so there is still time for you to get ahead of any changes—especially if you act now. 

To learn more, contact us to schedule a consultation. Our experienced Texas estate planning attorneys can guide you through the process.

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