Estate Planning for the Election: How the Election may Impact your Estate Plan

Each and every Presidential election tends to have some discussion of taxes.  The incumbent and the challenger discuss some of their plans on the campaign trail and debate some ideas on the stage.  It is no secret that President Trump and former Vice President Joe Biden have some very different ideas on the tax regime that should be in place if either were to win.  President Trump was a driving force behind the TCJA back in 2017.  If Joe Biden is elected, we could see some significant changes that rival the disruption to the tax law, which took place just three short years ago.  One change that would require immediate action from business owners, the estate & gift tax exemption.

This blog post will explore Joe Biden’s ideas for the direction of estate/gift taxes if he were to be elected.  Much depends on the results in the House/Senate, but it is never too early to plan.  Being proactive gives you at least some idea of how your estate plan may vary, given a change in administration.  Some of Joe Biden’s individual tax ideas have received a lot of attention, including restoring the top tax rate to 39.6% and changes to capital gains for high income earners.  There are also some significant departures in the estate and gift area, primarily focused on the two ideas below.

Two Main Changes to the Estate & Gift Tax Under a Biden Administration

  1. The reduction of the estate tax exemption (unified credit) to historical norms – the current exemption of approximately $11.5 million could potentially be cut in half to pre-TCJA levels, or be reduced even further to a level closer to $3.5 million for individuals.
  2. The elimination of the step-up in basis to fair market value upon death – heirs would potentially inherit assets with a carryover basis, or a potential tax upon death is another possibility.

Given the potential that these ideas become law, it may be prudent to act quickly.  The timing of any law changes is uncertain, but getting ahead of the game may be advisable given the magnitude of changes that can be classified as more taxpayer-adverse than the current regime.

Let’s take a look at a simple example

This example shows what wealth transfer looks under the current tax law, and how this might change if Biden wins and is able to push through a bill to change the law in the estate/gift area, focusing specifically on the estate/gift tax lifetime exemption.

Bob owns 100% of an S-Corporation, with a fair market value (determined by a qualified valuator) of $10 million.  Bob is a single taxpayer who has never made a taxable gift before.  Bob’s son Bill is in the business and Bob wants to transition some of his ownership to Bill.  Under the current estate tax regime, Bob gifts 49% of the S-Corporation stock to Bill.  Assuming no discounts for lack of control or lack of marketability (not a good assumption, but easier for the purposes of this blog post), the value of that gift is $4.9 million.  Since the exemption is currently over $11.5 million, Bob is not subject to tax on this gift and the stock is now out of his estate.  Even if the exemption were to be reduced in future years, there is no clawback, meaning that he still avoids estate tax on this gift as it was made when the exemption was at the $11.5 million level.

Under Biden’s potential plan, Bob gifts the same $4.9 million of stock, however, the exemption has been lowered to $3.5 million.  Now, Bob has an issue.  His gift is larger than the exemption amount by $1.4 million.  Bob now owes tax on that $1.4 million, to the tune of 40%, or $560,000.  There has also been discussions of raising the top rate from 40% to 45%.  Either way, a massive different from an estate/gift tax perspective.

Estate and gift tax exemption

Beyond the Tax Law

The current giving environment is also ideal for efficient wealth transfer as many businesses are still experiencing what is a (hopefully) temporary decline in the value of the business due to shutdowns and decreased economic activity.  Uncertainty surround the pandemic and economic outlook as we head into 2021 support lower valuations for businesses in many industries.  This provides a somewhat perfect storm for giving with depressed valuations and a large estate/gift tax exemption.

Ultimately, it is always a good time to do some estate planning, but it may never be more important than right now pending the results of the election in the White House and in Congress.

If you are a business owner and are worried about your estate plan, reach out to your estate planning attorney, CPA, business advisor, and a qualified business valuation expert, such as DKB’s Valuation Team.

If you missed it, make sure to tune in to this week’s A Minute with Mike discussing the estate and gift tax exemption under a Biden Administration.