Estate Planning

Estate Planning Under Biden Tax Proposals

If President Biden’s tax proposals go into effect, they will have an enormous effect not only on the way business owners run their companies, but also how they plan their estates. 

Currently, a married couple can pass tax-free an unlimited amount to each other, either during life or at death. Each person’s estate also has a tax credit that allows a spouse to pass $11.7 million to a non-spouse.  Moreover, the unused portion of the tax credit of the deceased spouse is “portable” to the survivor. This means that a married couple, in a properly structured estate can pass $23.4 million to children, an amount more than enough to shelter most small businesses from an Uncle Sam tax grab.

However, the Biden administration has announced it wants to lower a tax-free estate to $3 million. (It is not clear whether unused deductions will be portable.) 

The White House has also announced that it intends to raise the tax rate from 40% to 45%. The impact on a family business could be devastating.  Assume a couple’s business and other assets total $6 million, owned 50-50 between them. Assume the man dies first with a simple will leaving everything to the wife. Assume no portability. 

Her estate would then be $6 million with a deduction of $3 million, leaving a taxable estate of the same amount, and a tax bill of $3,000,000 x 45% = $1,350,000.  And the I.R.S. wants its money in nine months. The trick is making sure the available tax credit is used in each spouse’s estate so the tax credit available to the first spouse to die is not wasted. 

One way to do this is to use a “disclaimer trust” strategy where on the death of the first spouse everything is “offered” to the survivor. 

If the tax rules in place at the time allow the survivor to receive the assets of the deceased spouse without causing a tax problem, he/she would simply accept them. 

Where receiving assets from the deceased spouse would create tax exposure, they might be “disclaimed,” or not accepted. The deceased spouse’s estate would then use its $3 million deduction and no death tax would be due. 

The disclaimed money would then drop into a special sub-trust called the “by pass trust”– of which the surviving spouse is the beneficiary, with assets passing tax-free to children someday.

A second area of concern is that the president wants to do away with the “step-up” in tax basis on death.  An example:  If I give you IBM stock that I bought 50 years ago for $10 a share, and you sell it 10 years later for $110 a share, you deduct from the sale price what I paid for it (the donor’s “tax basis”) and pay a long-term capital gains tax on the $100 profit.  

However, if you get the stock from my estate, the tax basis “steps up” to the fair market value at my passing. If that value is $110 and you immediately sell the stock for that amount, you pay zero taxes. Loss of basis step-up is bad enough, but Biden also aims to essentially double the capital gains tax rate. 

His plan is a quadruple whammy: Reduction in the tax-free estate amount, increase in the death tax rate, doubling of the capital gains rate and loss of step-up in basis.  Too many children of business owners will find themselves having to sell the family business to pay taxes. 

Future articles will discuss techniques for minimizing the damage these new tax rules would bring about.

Legal Strategies is sponsored content produced by Johnson & Johnson Law Firm in Canfield.

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