How Would Proposed Changes to Federal Estate and Gift Taxes Affect Your Estate Plan?

By Brittany E. Cobb, LL.M. and William G. Smith, LL.M.

The Biden Administration and Congress are developing policy recommendations and have put forth legislative proposals that would significantly change estate and gift tax liability on inherited wealth. The following is a summary of the current proposals and their potential impact on asset preservation.

Estate Tax Rate Increase. Both Senators and Representatives have proposed increasing the tax rate of taxable estates. The maximum estate tax rate would increase from 39% to 65%. Additionally, these proposed tax rates would apply to taxable estates worth up to $1 billion.

Decreased Estate Tax Exclusion. The current estate tax exclusion for an individual is $11.7 million (effectively $23.4 million for married couples). However, under the legislative proposals, the exclusion would be decreased to $3.5 million for individuals (effectively $7 million for married couples). This legislative proposal would not increase taxes for 99.5% of Americans; it only affects the wealthiest 0.5%. Yet, under current law, the basic exclusion amount will decrease to $5 million after December 31, 2025.

Decreased Gift Tax Exclusion. Individual taxpayers currently also benefit from an $11.7 million gift tax exclusion, and under the proposed legislation and policy reforms, the gift tax exclusion would be dramatically reduced to a mere $1 million.

Annual Gift Limitations. The proposals would cap total aggregate annual gifts at $20,000 per individual donor, and cap each individual gift at $10,000 per donee. With parents giving almost $40,000 to their adult children to help purchase a house and as much as $12,000 to pay for a wedding, without carefully planning these gifts, this provision would cause unforeseen gift tax liability and additional gift tax filing requirements.

Eliminating Capital Gains Tax Rate for High-Income Earners. For individuals who earn over $1 million of annual gross income, the preferential capital gains rate would no longer apply to any appreciated capital assets. Any realized capital gains would be taxed as ordinary income. Currently, ordinary income is taxed at 37% for individual taxpayers. Coupled with an income tax rate increase, this would nearly double the tax paid on capital gains by high-income earners.

Disallowance of Step Up in Basis and Imposition Capital Gains Tax on Estates. Currently, all accumulated gain on capital assets can be inherited under the stepped-up basis rules of the tax code. However, only the first $1 million of appreciated capital gain would be exempt from capital gains tax, and any remaining appreciation would be taxed as ordinary income to the estate. At the current highest ordinary income tax rate, those capital gains would be taxed at 37% instead of the preferential 20% capital gains rate.

Additional GRAT Requirements. Grantor Retained Annuity Trusts (GRATs) would be required to have a minimum 10-year term and a maximum term no greater than 10 years longer than the life expectancy of the annuitant.

Application of GST to Grantor Trusts. Grantor Trusts would also only escape the generation-skipping transfer tax for a maximum of 50 years. After the 50-year term limit, all distributions would be subject to the highest applicable estate tax rates.

Although we do not know which, if any, of the above proposals will be passed or the details of the final versions, there is still opportunity to avoid the harsh consequences of these legislative proposals. We recommend that individuals review their current estate plans and tax strategies now to determine if immediate action is needed to mitigate some potential tax consequences prior to the enactment of new laws.