Client Alert — Major Changes on the Horizon to Federal Estate Tax

Major changes to the federal estate tax exemption are likely looming, perhaps as soon as January 1, 2022.

The “estate tax exemption” refers to the amount of wealth you can pass upon your death tax-free.  Assets above the exemption amount are subject to estate tax.  The federal estate tax is one of the highest tax rates—40%.  To the extent you make taxable gifts during your life, the exemption amount available at your death is reduced by the cumulative amount of these gifts.

The Bad News

In 2017, as part of the Tax Cut and Jobs Act, the estate tax exemption was increased to $11.58 Million per individual taxpayer, from $5 Million.

In September 2021, the House Ways and Means Committee released a proposal that would reduce the exemption to approximately $6 Million per individual taxpayer.  It is anticipated that this proposal will become law.

Notably, the House proposal would also increase the scope of assets subject to estate tax by abolishing the estate tax benefits of certain grantor trusts.  Clients historically utilized many of these types of trusts to relinquish control of an asset so that the asset is not counted against their estate tax exemption.  The House proposal would change that and instead include many of the assets held by these grantor trusts in an individual’s “taxable estate” (the value of their estate counted against the exemption).  This, in turn, will increase the value of an individual’s “taxable estate” and increase the amount of wealth subject to estate tax.

The Good News

First, the unlimited marital deduction looks to stay.  What does that mean?   The full extent of wealth left to a surviving spouse generally remains tax-free.  Moreover, the portion of your wealth left to a surviving spouse does not count against your exemption.  So if you leave all of your wealth to your surviving spouse, you have also not used any of your exemption.

Portability looks to stay.  What does that mean?  Any unused amount of your exemption can be combined with your surviving spouse’s exemption upon your spouse’s later death, provided certain tax filings and elections are made within 9 months of the date of your death.  In other words, if you leave your entire nest egg to your surviving spouse, your surviving spouse can combine his/her $6 Million exemption with your unused exemption and bequeath up to $12 Million of tax-free assets.

It looks like the “step-up” in cost basis at death will not be lost.  As we discussed previously, the “step-up” means that an asset is revalued as of the date of death for capital gains purposes.  This is incredibly important for clients who hold significantly appreciated assets at the time of death, such as real estate acquired several decades ago (or professional sports teams).

The Caveat

Please note that this discussion only relates to the federal estate tax.  Both the District of Columbia and the State of Maryland have different tax rates and different exemption amounts for state estate tax.

If you would like to review your estate plan in light of the potential changes to estate tax laws, please contact Jeremy Rachlin, Partner and Chair of the Estate and Trust practice group at Bulman Dunie.