The Tax Cuts and Jobs Act (TCJA) of 2017 brought great changes to the estate tax regime.
The estate tax exclusion was doubled and indexed to inflation, subjecting estates larger than $11.2 million to a 40% rate, with double that figure allowed for married couples. For 2020, the exclusion stands at $11.58 million for individuals.
President Donald Trump’s administration rated TCJA as a victory, but it’s important to recall that it was a compromise. President Trump would have preferred to eliminate the estate tax. Estate planners and financial advisors may need reminding that the estate tax exclusion will revert to the pre-TCJA threshold at midnight, December 31, 2025. An unhappy New Year is awaiting advisors who let this deadline go unmarked with clients.
What will happen in 2026 and beyond? Will the Trump administration allow the estate tax exclusions to return to old normal, or will they fight to keep the TCJA provisions in place – or perhaps propose even bolder steps in the estate tax realm.
This is a bit of a trick question because it presumes a certain outcome to the November 2020 election. While Trump does have the incumbent advantage, he faces strong headwinds. Remember, his current stay in the White House is the result of an historic upset and it’s difficult to say what November will bring.
A review of the estate tax proposals of prospective candidates and key observers may help in preparing for the coming years. President Trump has not released any specifics on post-election tax plans but has indicated support for continuing the trends set by TCJA, with amendments aimed at supporting middle and lower-income citizens.
The president’s statements since TCJA’s passage suggest he wants the new exclusion limits extended. Likely, he hopes to go deeper, possibly eliminating the estate tax altogether. Whether this would be possible depends on the economic environment at election time. Even after a potential win, Mr. Trump could face tax cut resistance from the general public, depending on how the suffering caused by the coronavirus crisis plays out in their collective pocketbooks.
Former VP Joe Biden currently stands as the Democratic Party’s presumptive candidate. His proposals for increasing taxation are less extreme than commonly assumed, but he does wish to raise income taxes on wealthy earners (those with incomes north of $400,000), cap the value of itemized deductions, raise other rates, and most importantly for our discussion, eliminate the basis step-up on inherited assets.
The step-up often works mightily in favor of heirs, because the inherited assets are valued at the time of the original owner’s death. If an heir sold their rich inheritance off rapidly enough, the capital gains tax bill would be limited. Estate planners are used to planning around the step-up, but we counsel a close examination of Mr. Biden’s proposal and the formulation of ‘plan-B’ solutions for effected clients.
Biden’s proposals could increase the tax take by $3.8 trillion over a decade, based on estimates, but also might shave 1.51% off the long-term growth rate. The general population cares little about the tax bills of the wealthy, but they do care about growth, the engine of employment. November will tell its tale, but election victory alone doesn’t guarantee a policy’s implementation.
Bernie Sanders is out of the running, but his ideas have gained some popularity with the general population, even those who bitterly oppose him. A Morning Consult/Politico poll conducted last year found that Sanders’s proposal to cut the estate tax exclusion to $3.5 million was favored by 50% of respondents.
While Sanders won’t be the nominee, horse trading is an ordinary part of the political machine, both in elections and legislatures. In the right environment, seemingly extreme proposals can suddenly take on life.
Former advisor to President Barak Obama, Professor Lily Batchelder, thinks the Democratic Party should approach the inherited wealth problem in a radically different way. Her ideas have echoed in some business circles as a way to simply the tax code, accept modest tax rises on the wealthy and expand the taxable base. Ms. Batchelder has suggested mothballing the estate tax and considering inherited assets as ordinary income, taxable as such. This would only sting the most affluent, she believes, and provide the government with resources for helping the nation’s poor. Her assertions sound reasonable, though any predicted outcome is open to challenge.
Globally, inheritance taxes, paid by the recipient, are commoner than estate taxes, which are assessed against the bequeathing party’s estate. Pundits of a progressive inheritance tax argue that it would encourage the spreading of assets to multiple beneficiaries, including charitable groups, thereby addressing the problem of wealth concentration. Reasonable tax rates and exemptions would incentivize smaller bequests and only excessive sums, as defined by law, would be penalized, they say.
Could the Democrats and Republicans ever decide to approach the inheritance problem in untraditional ways? It seems unlikely in this gridlock era, but they worked together constructively in the past and may do so again. Changes are coming to the estate tax realm and while extreme course changes are unlikely, these days, it’s wise to prepare for surprises.