In this last in the series of Blogs I write detailing the differences between the two Presidential candidates tax plans, I think it’s only fitting that in light of the upcoming Day of the Dead Holiday, we talk about…. DEATH! So let’s dig in.
There are two huge differences between the two candidates on taxing estates and heirs.
If you pass away with an estate below a certain value threshold, your estate will incur zero estate tax. This is widely known as the inheritance tax, but it is technically assessed against the estate, not the heirs. Taxing dead people, especially wealthy ones, has been a political game of kickball for many years as each administration determines what, if any, that value threshold will be. And let’s face it, wealthy dead people are easy targets. They don’t vote (except in Chicago) and the general public has little sympathy for them.
Some of you may remember back when that wealth threshold was as low as $600,000. It bounced around over the years depending on the flavor of Congress and the administration and currently sits at $11,580,000 per person. This means that a married couple could die in 2020 and pass $23,160,000 to their heirs tax free. It makes transferring wealth a lot simpler for estates that size and smaller. Anything over that is generally taxed at a rate of 40%. This $11.58mil threshold is adjusted annually for inflation but is currently slated to revert back to $5,000,000 in 2025.
The Trump plan would extend the current threshold past 2025. The Biden plan would lower the threshold to $5,000,000 right away. This would have a huge effect on estate planning and gifting for many people who will see the huge amount of taxes their estates would owe under the Biden formula. For many estates consisting of real property or other illiquid assets (such as a business or a farm) a huge tax bill would force sales of assets that the heirs intended to keep within the family. For this reason alone, if Biden should make the cut in November there will be a flurry of restructuring activity before the end of 2020. We are already seeing it in our practice. It’s a potential savings of $5,264,000 for a joint estate exceeding the $23,160 mil threshold. I don’t care who you are, that’s a lot of money,.
The second major issue with death we have has to do with basis step up. Let’s say that you inherit a home from your deceased parents and want to sell it. Mom & Dad bought the house decades ago for $100k and it’s now worth a cool $1mil. If Mom and Dad had sold the house before they died they would have had a gain of 900k, right? (ignore the personal residence exclusion for my example) Under current law if the estate sells the house the estate gets to assume that the cost basis of the house was its fair market value on the date of death. So, FMV= $1mil and sales price = $1mil, no gain and no income tax due. The reason for this is because in theory the fair market value of the house would also be includable in the estate tax calculation above, and it’s been public policy not to tax such assets twice. Most (not all) assets receive a “step up” in basis when the owner dies, and its been a very valuable tax planning tool for couples and families. It also makes life much easier for accountants! Can you imagine trying to determine the cost that Grandpa paid for the farm and house he built fifty years or more ago that you inherit? And any improvements made since? How would you expect people to keep records of that across generations to prove numbers to the IRS? It would be a nightmare.
The Trump tax plan does not change the step up on death landscape. The Biden plan would eliminate the Stepped up Basis, plunging us into the nightmarish scenario of double tax and ridiculous documentation expectations.
To illustrate using my numbers above after the family pays $400,000 of estate taxes on the value of the house ($1mil X 40%), the house is sold by the heirs and they owe capital gains taxes of $180,000 (900,000 X 20%) or possibly 39.6% under Biden’s Capital Gain rate proposal. In that worst-case scenario, your $1 mil inheritance is reduced by Federal taxes of (400 + 396k) or 796k, leaving you with only 204k out of $1mil. And that’s not counting any state taxes that may be levied. Yes, I am assuming fully taxable estates and maximum income tax brackets, but you get the point.
If we see a change in administration and there is a short estate planning window between November 3rd and Dec 31, don’t be surprised if more than a few elderly clients suddenly accidentally expire. I’d take a close look at their heirs and see if maybe they took over taking grandma to the park that day…
it could get really ugly.