Planning Bulletin: The Biden Tax Proposals – Chapter 2

Transfer Taxes with a Side of Capital Gain!

The Problem

In our previous Planning Bulletin, The Biden Tax Proposals Chapter 1, we focused on the Biden administration’s proposal to both increase the long-term capital gains rate and make it retroactive to the month of April. In “Chapter 2,” we focus on another, somewhat unexpected, proposal: that gifts of appreciated property would trigger the immediate recognition of taxable gain.

Let’s look at that more carefully:

Specifically, the proposal is to tax unrealized appreciation in assets passed at death or gifted during a lifetime, subject to certain exclusions, as a realized capital gain. A “mark to market” approach. This is in addition to any gift, estate, or GST tax that would otherwise be generated. Talk about double taxation! For example, a person wants to remove assets from their estate using the common technique of gifting assets to an irrevocable trust for the benefit of their heirs. If that asset consisted of a $15 million securities portfolio with, let’s say a $5 million dollar cost basis, in the year of transfer, that person would pay a federal gift tax of $1.32 million ($15m — $11.7m1 = $3.3m x 40%) and an even greater federal capital gains tax of approximately $$3,710,0002 In fact, in a worst-case scenario, one could be taxed on over 80% of their estate.3

The same would be true for gifts to heirs at death. Hence, these proposals essentially do away with the “step-up in basis at death,” which has been a bedrock principle in estate planning for a very long time. This is to say, because there is a capital gain tax based on the fair market value (FMV) of the asset at death, it takes on a new tax basis equal to that FMV…..but now, painfully, at the cost of a current, high rate, capitals gains tax. Of course, we don’t provide tax advice and the examples here are for discussion only.

Exclusions and Exemptions

There are some, not overly generous, exclusions to this tax: 1) tangible personal property (excluding collectibles); 2) A general exclusion is available to each individual person of $1 million; 3) The $250,000/per person ($500,00/couple) exclusion for capital gains from the sale of a principal residence would still be available;4 4) Qualified small business stock (QSBS) will remain immune from income taxation.

Some “transferees” are also exempt in particular, surviving spouses in the case of transfers at death,5 and gifts to charity. Although, it’s interesting to note in the case of the latter, if it is a gift to what are called “split-interest” trusts, for example, a charitable remainder trust (CRT), only the portion that is calculated to go to charity will qualify for the exemption.

Also, important from a planning standpoint is that the proposed effective date of these changes is 1/1/2022. So, giving a fairly generous runway for planning.

Thoughts/Conclusions/Solutions

As a former CIA chief once said, “The first thing is not to panic!” Again, these are proposals and not tax law, or for that matter even a bill before Congress. There is much conversation in smoke-filled rooms still to come. Yet, it would be foolish not to be mindful that these proposals could, as many have, ultimately make it to the finish line.

Having said that, with a stated effective date of 2022 there is ample time to watch things develop and begin to think about alternative action plans.

In that vein, should you, or a client of yours, have a large estate, that includes highly appreciated assets, this could be a catalyst moment. Consider that: 1) the gift tax exemption is at a historically high $11.7 million/person; and 2) that both it and the possibility that gifting, during life and at death, will trigger capital gains taxation, are under threat. So…if this estate planning should be done anyway, this might very well be the time.

1 Some good news here is that the transfer tax exemptions (estate, gift, and GST) are not being targeted for reduction as had been much anticipated.
The $10m gain, less the $1m exclusion, under the new long-term capital gains taxation regime (which one assumes would apply here, of ordinary income rates on the amount over $1m of AGI.)
In a situation where there was no exemption left and all assets had a zero basis.
4 An early interpretation is that this would effectively be an addition to the $1m exclusion.
There is no language addressing an exemption in the case of lifetime transfers, but many assume this would be corrected going forward.

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Nicholas Bertha
Director of Wealth and Trust Planning, Fieldpoint Private Securities, LLC