As President Joe Biden takes office, he’s signaled his intentions to make sweeping changes. He has signed executive orders on everything from combating the COVID-19 pandemic and climate change to increasing food security and widening the economic safety net.
Some of these changes have been forecast since the days immediately following the election in November. Others, such as how or if Biden will change how estates are taxed, are leaving wealth managers in limbo.
“In terms of how a Biden administration is going to make changes to estate taxes, we’re really taking a wait-and-see approach,” says Peter Antonoplos, founder of Antonoplos & Associates, a legal firm in the District of Columbia. “It’s really anyone’s guess where they’re going to end up.”
Potential Changes to Estate Taxes in a Biden Presidency
Among the tax-related changes made during the administration of former President Donald Trump was the raising of the lifetime exemption, which is the amount an individual or a couple can give away without paying tax.
The lifetime exemption rose from nearly $5.5 million per person in 2017 to $11.2 million in 2018. For 2021, the exemption reaches $11.7 million for individuals and $23.4 million for married couples. The federal estate, gift and generation-skipping transfer tax rates are generally as high as 40%.
Biden, however, has indicated that he may lower taxpayers’ federal estate tax exemptions. The reduced amount could fall to about $5 million per individual and $10 million for a married couple. Some members of Congress have called for the exemption to be lowered even further — to $3.5 million per individual or less before the current provisions are set to expire in 2025.
Preparing for Estate Tax Changes
For some high-net-worth clients, failure to plan for the potential loss of this elevated exemption could result in a major tax bill down the road.
Wealth managers of high-net-worth clients began making subtle changes to their portfolios last year upon predictions of the Biden win. But it was only in January when Georgia Democrats Jon Ossoff and Raphael Warnock won their Senate runoff elections, and the Democrats took control of the Senate, that advisors began ramping up their contingency planning.
“Those conversations with clients really started last year when people started looking at the election,” says Jeff Chadwick, member of the wealth preservation practice group at Winstead, a law firm in Texas. “Anytime there’s a potential blue sweep, there are folks interested in doing some changes ahead of that. A lot of clients did things by the end of the year to move funds around, create trusts, that sort of thing.”
Most estate planning clients tend to fall into one of three categories, Chadwick says.
“They’re either unlikely to have a taxable estate and are driven by nontax factors like helping out a family member or donating to charity. On the other end of the spectrum are the high-net-worth individuals, and those are people who will probably have an estate tax liability as long as the estate tax exists,” he says.
“The hardest people are the people who are right in the middle,” Chadwick says. These clients may have a net worth from $10 million to $25 million.
“They’re hard because they don’t have an estate tax problem today, but if the law changes, they do,” Chadwick says. “A lot of times, they can’t afford to give everything away, but if they don’t do something, they could have a pretty steep tax.”
But any changes to the estate tax table aren’t likely to happen soon, says Sarat Sethi, chartered financial analyst, chartered investment counselor and managing partner at Douglas C. Lane & Associates. Sethi’s company manages $7 billion for high-net-worth individuals, including acting as a fiduciary. “There’s a lot of uncertainty and a lot for Congress to go through,” Sethi says.
How Financial Advisors are Counseling Clients
Despite the uncertainty, some financial advisors are counseling clients to make subtle, strategic moves in the coming months.
“Our advice for our clients is the same it’s always been until we know more. These changes could be moved to 2022, or they could be made in June and apply retroactively to January. But it’s best to be queued up for a variety of possibilities,” Sethi says.
“Create an if/then chart in your mind or on paper,” Sethi says. “You don’t need to get it fully drafted up, but I would suggest the advisor engages with the discussion, especially now, so they’re ready to go when the changes come and are not left scrambling.”
Chadwick’s recommendations include using existing bonus exemptions before they expire. “If a taxpayer elects to use his or her bonus exemption in 2021, the IRS has stated that there should not be a ‘clawback’ if the exemption is decreased in 2021 or future years,” Chadwick says. “Consequently, taxpayers who may have a taxable estate should consider utilizing their bonus exemptions while they still can.”
Bonus exemptions refer to the difference between the current exemption rate minus the expected future amount. The current “bonus” exemption rate is $6.7 million, which is the current rate of $11.7 million in 2021 minus the $5 million expected exemption rate in the future.
“The bonus exemptions are ‘use it or lose it’ amounts, so we are encouraging clients to use their bonus exemptions if they can,” Chadwick says.
The same is true of planning tools, such as valuation discounts or grantor-retained annuity trusts, typically used to make large financial gifts to family members without paying a U.S. gift tax. Antonoplos recommends accelerating capital gains if a client is able.
While nobody knows for sure what changes the Biden administration will make, if any, there are other ways to prepare. For example, planning can take place for a client, such as an entrepreneur on the cusp of a large deal or round of funding, who may know that the year will bring additional fortunes.
“If I know a client is going to have an event that will have a huge upside, I want to have those conversations now,” Sethi says. “You can still do planning with people who are going to have major events, even if you don’t know what Congress will do.”
Sethi’s advice for high-wealth individuals is the same advice many advisors wish all their clients knew: Don’t wait until the last minute.
“We should be talking with our clients now and not wait until a new law goes into effect,” he says. “We don’t know what’s going to happen, but we know what we have now.” If clients aren’t able to have those conversations with their advisors, it’s also a good time to begin the process of finding and vetting a new advisor, if needed.
“There’s a realistic danger that we’re going to wake up one day, and there are going to be comprehensive tax changes passed that are effective immediately, and clients have missed the chance to take advantage of those opportunities,” Chadwick says.
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Financial Advisors Eye Biden’s Plan for Estate Taxes in 2021 originally appeared on usnews.com