Brendan Bybee, Esq., Senior Associate Attorney at Stone Law Offices, Ltd.
With a new administration in the White House, a shift of control in Congress, and a continuing pandemic impacting the economy, we can reasonably expect some changes to the tax laws in 2021. While you may be somewhat preoccupied with 2020 taxes, as you prepare to file returns, you should also be aware of what changes may be in store for 2021 and what opportunities you may have before those changes go into effect.
Income Tax Changes
With respect to income taxes, the President’s policy agenda largely targets tax increases to those earning $400,000.00 or more. If you are a top earner, you may expect to see the following changes in forthcoming tax legislation:• 12.4% payroll tax on income above $400,000.00
• Top income tax rate reverts back to 39.6%
• Long term capital gains taxed at ordinary income tax rates on income above $1,000,000.00
• Itemized deductions capped at 28% for top earners
• Phase out of qualified business income deduction
On the other hand, if you have more modest income you may expect to see some favorable changes, such as:
• Expansion of the Child and Dependent Care Tax Credit to cover 50% (up from 35%) of child care expenses up to $8,000.00 (up from $6,000.00) per child for up to two children
• Expansion of the Earned Income Tax Credit to childless workers aged 65 and older
• Return of the $15,000.00 First-Time Homebuyers’ Tax Credit
Capital Gains Tax Step-up
One of the more striking changes being discussed is a proposed elimination of the basis adjustment for appreciated assets at death. Currently, when you pass property to another at death, the cost basis for that property, for the purpose of calculating a taxable capital gain, is adjusted to the date of death value for the recipient. For property that has increased in value since you first purchased it, this results in a “step-up” in the cost basis for your recipient. Since the capital gains tax is assessed on the difference between the cost basis and the sale price of the property, this basis step-up practically eliminates the capital gains tax for a beneficiary that sells the property promptly after acquiring it.
Eliminating the basis step-up could clearly have an adverse impact on surviving spouses (as well as other heirs) which could make such a proposal politically unpopular and difficult to pass. However, any proposed legislation is certain to include come mitigating exemptions to address this and other consequences but details on what those might be are not yet available.
Previous efforts to eliminate the basis adjustment have been unsuccessful and it is unclear how much support there is for the proposal. As such, it may be somewhat of a longshot that such a proposal is passed into law yet it is not outside the realm of possibility. If the step-up is eliminated, we may see an increase in the use of charitable remainder trusts and other capital gains tax mitigating strategies.
Estate and Gift Tax Changes
In 2018, Congress temporarily increased the estate and gift tax exemption to $11,280,000.00 per person, with inflationary increases. In 2021, the exemption is $11,700,000.00. If nothing is done, this approximate doubling of what was already a historically high exemption will expire at the end of 2025. However, we are very likely to see this increase expire much sooner and may even see the exemption decreased even further. The President has spoken favorably of proposals to lower the estate tax exemption to $3,500,000.00 while increasing the rate to 45% (from 40%) and reducing the gift tax exemption to only $1,000,000.00. Such changes, if enacted, would make estate and gift tax planning a legitimate concern for a much larger portion of the population.
Most tax legislation is made effective in the year following passage but it is not uncommon to see changes be made effective back to the beginning of the year. To be constitutional, retroactive changes need only be “rationally related to a legitimate legislative purpose.” Given the slim margin of congressional control, retroactive change may be somewhat less likely but not entirely improbable.
2021 Planning Opportunities
With the estate and gift tax exemption at an all-time high and significant changes on the horizon, 2021 presents a special opportunity for clients with sufficient means to make use of the high exemption before it is gone. Planning under the specter of retroactive tax legislation presents particular challenges including the risk that gifts made under existing exemptions may later be made taxable if exemptions are lowered. However, there are techniques that allow some opportunity for after the fact adjustments to large gifts if retroactive changes do threaten an adverse result. So, while there is uncertainty about the fate of the high 2021 exemption, there is also relatively low risk to gift planning in the meantime.
While 2021 could bring significant change, we can only speculate until legislation is actually presented and passed by congress and signed into law. Nevertheless, now is an excellent time to consider how your finances and estate planning may be impacted so you can make proactive decisions, explore alternatives strategies, and take advantage of expiring opportunities.