Tax Law Roulette

Speculating about tax law legislation is a lot like speculating about the weather. Even when you use the best instruments (barometers, hygrometers, radar, etc.), the weather can throw you a surprise from left field. The same can also be said for predicting tax legislation.

Logic would dictate that the Democrats would try to pass a big tax law change to counteract the Tax Cuts and Jobs Act (“TCJA”) of 2017, which had a wide-ranging effect on individuals, businesses, tax-exempt and government entities. Recently, the Economic Policy Institute and the Center for Popular Democracy studied the latest evidence about who benefited most from the TCJA. The report, Still Terrible at Two, shows that despite Republicans’ claims of success, President Trump’s tax bill did not increase wages for working people, failed to spur business investments, decreased corporate tax revenues, and boosted stock buybacks in its wake. The Republicans would likely disagree with this analysis, but the Democrats now have control (albeit by a razor-thin margin) of both Congress and the Presidency.

Current political dialogue only gives passing lip service to tax legislation initiatives. During President Biden’s first news conference, he made what seemed like an off-handed reference to paying for COVID relief through taxes while at the same time criticizing the TCJA for disproportionately benefitting the wealthy. There are certainly more prominent agenda items, including infrastructure, gun control, and climate change.

Nevertheless, Senator Bernie Sanders recently floated a proposal and introduced legislation to tax the more fortunate top .5% of taxpayers by lowering the estate tax exemption to $3.5 million per person from the current $11.7 million, increase the rate of tax to 45% or higher, and eliminate dynasty trusts that last more than 50 years. Another potential change relates to the “step-up” in income tax basis when a person dies by either reducing or eliminating the step-up. Lastly, gifts made while alive would be limited to an aggregate of $1 million. These changes are proposed to become effective on January 1, 2022, and not retroactive to the beginning of 2021.

Given the direction of the debate, and the current Democratic majority, it is prudent for clients to assess whether to take advantage of current law that allows a generous $11.7 million of exemption either during life or after death. Fortunately, the IRS has ruled there will be no “claw-back” of exemption used beyond the level of the law in effect at a decedent’s death. For example, if the exemption reduces to approximately $5.5 million in 2026 as the current law provides, then exemption used beyond that $5.5 million would not be “clawed-back.” Strauss Attorneys prepared a graphic illustration calling this the “bonus exemption” and is available on request. Several of our married clients have decided to use this “bonus exemption” by gifting it to their spouse, thereby removing the gifted assets, and any of the assets’ future growth, from their taxable estate. It is also possible for a single client to gift the “bonus exemption” to a domestic asset protection trust (DAPT) where he or she is a permitted discretionary beneficiary.

The bottom line is that the TCJA, along with the IRS’s pronouncement of no “claw-back,” presents a time-sensitive opportunity to implement tax planning that could benefit your family for generations to come. It could truly be a use-it-or-lose-it proposition, and one worthy of consideration before the pendulum possibly swings back to a more restrictive estate transfer tax environment.