Every few years, elections shake up Congress and the White House. And with that comes new faces and an injection of new ideas regarding taxes. That’s created significant policy churn over time and yielded a system of taxation that is complex and, in many ways, unpredictable — especially from one election to the next.
This fall, taxes will likely become a focal point once again for the Biden administration and other lawmakers in Congress. While no one knows exactly what will happen, changes are probable, and they could have sizable implications, particularly for high-net worth individuals who are planning to take advantage of a significant, though temporary, wealth transfer tax exemption.
“While tax laws are certain, they are not static. Changes in tax laws significantly influence the decisions we make for ourselves, our families and our businesses and it’s imperative that our financial plans change with them,” says Melinda Rider Rochelle, JD, LLM, senior director of concierge planning at Northwestern Mutual.
Here’s what’s at stake and why now is the time prepare your estate for a variety of legislative outcomes regarding the gift tax and estate tax in the months ahead.
GIFT TAX AND ESTATE TAX EXEMPTIONS IN QUESTION
The federal government currently imposes transfer taxes, with the highest rate of 40 percent on lifetime gifts and transfers at death. In 2018, following passage of the Tax Cuts and Jobs Act of 2017, the exemption from this tax doubled and currently stands at $11.7 million per person ($23.4 million per married couple), adjusted for inflation. The current law sunsets on Dec. 31, 2025, at which time the exemption will revert to $5 million, again adjusted for inflation.
Essentially, this created a unique window of opportunity to make tax-free gifts of up to $11.7 million per person. However, to fully benefit you need to either pass away or make lifetime gifts before the exemption window closes. We’ve known with certainty that this exemption period would end in 2025. However, Congress could decide to close the window sooner.
A POLICY SHIFT ON THE HORIZON?
During the presidential campaign, Biden proposed decreasing the estate tax exemption from its current level of $11.7 million to $3.5 million and decreasing the gift tax exemption to $1 million.
So far, the Biden administration has focused on economic aid and the logistics of fighting a pandemic, but attention is likely to shift to taxes in October when a new fiscal year for the federal government begins.
It isn’t clear if taxes will take priority, or what concrete policy would emerge from Congress. The Senate is held by the slimmest Democratic majority, so negotiations are inevitable, and they would likely alter a final proposal from Capitol Hill. While it’s likely changes won’t take effect until 2022, there’s still a chance that some changes could retroactively apply to Jan. 1, 2021.
This puts some taxpayers in a difficult position because they may need to act on their estate plan without knowing what the future holds. Should a taxpayer, for example, make transfers now to lock in the exemption, or is it already too late because the law may apply retroactively? While it’s difficult to predict what Congress will do, you can assess your level of risk exposure and take action to help shield your estate from a variety of legislative outcomes.
ARE YOU EXPOSED TO TRANSFER TAX RISKS?
This is the first step, because the magnitude of this problem (or urgency to lock in the exemption) depends on your individual, projected net worth at death.
Less than $3.5 million: It’s unlikely that you’ll owe federal estate taxes under both the current tax regime and any future tax environment that may emerge from Congress in the nearer term. In other words, you may be hearing a lot about transfer taxes, but you probably don’t need to worry. Instead, remain focused on comprehensive planning, saving for retirement and estate planning.
Between $3.5 million but less than $11.7 million: You may not have an issue today, but you may have one in the future if the lifetime exemption is decreased. It may be worth considering a large gift to take advantage of the higher exemption that exists today, so long as doing so doesn’t jeopardize your current and future lifestyle needs.
More than $11.7 million: If you have a taxable estate of this size under current law, any reduction in the gift and/or estate tax exemption will increase your tax liability. However, if the current law does not sunset but is replaced with even lower exemption levels your estate will be exposed to additional tax risk. It may be prudent to begin reducing the size of your estate through gifts today, but only if it aligns with your long-term objectives and priorities.
YOU CAN STILL PLAN AMID POLITICAL UNCERTAINTY
Estate planning strategies can be complex, and it’s always wise to speak with a financial advisor, tax attorney or accountant to devise an optimal path that aligns with your financial and wealth succession goals.
“Now is the time to reach out to your financial advisor to discuss how changes could affect you, your family and your business, as well as the action steps you may need to take in order to ensure that your financial plan—your goals and objectives—remains secure,” says Rider Rochelle.
If you want to reduce the size of your taxable estate but retain some access to your assets, there are a few options to discuss with your advisory team. You can even set up transfers that are reversable, or essentially cancel out, if the changes apply retroactively. Simply put, you have options.
Ultimately, there’s no telling what the tax regime will look like next year or 20 years from now. However, the current historically high transfer tax exemption presents a unique opportunity to make a large transfer tax-free gift before the law changes.
If you’re feeling anxious about tax law changes that could be coming, speak with your advisory team to get the ball rolling. There are things you can do today, but your range of options may shrink in the not-too-distant future.
This publication is not intended as legal or tax advice. Northwestern Mutual's and its Financial Representatives do not render tax advice. Consult with a tax professional for tax advice that is specific to your situation.