Biden’s Estate Tax Overhaul: Forewarned Is Forearmed

While it may not come to fruition, the American Families Plan includes the largest tax increase on the wealthiest in over a century.

High-net-worth clients could see some of the most substantial transfer tax increases in their lifetime if the proposals in President Joe Biden’s American Families Plan become law. According to Tax Foundation calculations, taxes on transfers of accumulated wealth at death could rise to around 61% for the wealthiest taxpayers — the largest tax increase in more than a century.

While the wealthiest families would bear the brunt of the estate tax burden, even moderately well-off families could see significant increases in their overall tax liability on postmortem transfers under the latest proposal. Now that the dramatic details have emerged, the question becomes: Are your high-net-worth clients prepared for what’s to come/?

The Current Estate Tax Regime

Under current law, taxpayers who own appreciated assets can often transfer those assets at death without recognizing any gain. If sold, capital assets held for more than one year are subject to a maximum long-term capital gains rate of 20%. Upon sale, the 20% rate (23.8% when the investment income tax is factored in) is applied to the difference between the sale price and the basis in the property (usually, the original purchase price plus any capital improvements made during the owner’s life).

When assets are transferred at death, however, the recipient benefits from a step-up in basis. The original owner’s basis is “stepped up” to the fair market value of the property at the date of death. If the beneficiary later decides to sell the property, capital gains are owed only on appreciation between the date of the original owner’s death and the date of sale.

A simple example can illustrate. Assume Ada is an entrepreneur who started her own business in 1990. Over 30 years, the value of the business has soared to $100 million. When she died in 2020, she left the business to her son, Jake. Under current law, when Ada died, Jake’s basis in the business would be “stepped up” to present-day fair market value ($100 million). In other words, Jake wouldn’t be liable for any capital gains taxes at death — he would be liable only for capital gains if he later sold the business at a higher value.

Biden’s Proposed Changes

The Biden tax plan would eliminate the stepped-up basis rules. However, in a surprise move, any unrealized asset appreciation would trigger taxation on the date of the original owner’s death — regardless of whether the beneficiary actually sold the property.

Each individual would benefit from a $1 million exemption ($2 million per married couple) and the exemption would be portable between spouses upon the death of the first spouse. Based on the example above, assuming Jake is single, he would owe capital gains taxes on $99 million (the fair market value of the business at death minus the $1 million exemption). That would be true even if he elected to hold on to the business.

The asset transfer at death could also be subject to the 40% estate tax (at times, Biden has also proposed reducing the current $11.7 million per-person estate tax exemption to pre-2017 levels of around $5.3 million per person). It’s also possible that further changes could be made to alter the current estate tax regime to limit the double taxation issue. On the other hand, Biden has also proposed increasing the top estate tax rate to 45% (many of these proposals were not included in the recently released Green Book, but they could still be part of the overall legislation).

The full impact of the immediate recognition rule really kicks in when the proposed increases to the capital gains tax rates are considered. The latest tax plan proposes taxing long-term capital gains for millionaires at ordinary income tax rates — and the top ordinary income tax rate would increase to 39.6% under current proposals. When combined with the 3.8% net investment income tax on high-income clients, that means the top capital gains rate could increase to 43.4% (as opposed to a maximum of 23.8% today).

While the details remain unclear, it also seems likely that many currently available estate planning techniques would be eliminated or restricted.

Conclusion

As these and other proposals continue to work their way through Congress, it’s highly possible that some of the proposals could change or be abandoned entirely. But high-income clients should start to evaluate potential estate planning changes and strategies immediately to prepare for changes we might see in the near future.

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