There are potentially more new tax laws likely to affect Californians this year than Proposition 19, which we’ve covered extensively here in this blog and through a series of webinars. (Prop 19 went into effect on February 16, dramatically changing property tax rules in California around intrafamily transfers of real estate, what can be exempted from reassessment, and imposing limits on other property tax benefits – learn more.
While the implications of Prop 19 for Estate Planning are far-reaching, potential federal tax law changes for 2021 and beyond may pose major consequences for Californians as well. With a new administration in Washington D.C., it’s likely American taxpayers eventually will see tax increases. Whether any tax hikes will be enacted in 2021 and whether any will be retroactive remain big question marks. If they are, then the already complicated matter of Estate Planningbecomes even more complex.
At Shoup Legal, we’re keeping a close eye on tax law policy at both the state and federal level. Speculation has it that Washington D.C. is currently eyeing a reduction in the “estate tax exemption” and elimination of the “basis step-up” for inherited property.
What it Could Mean
Estate Tax Exemption—The Tax Cuts and Jobs Act of 2017 provided an individual exemption amount increase up to$11.7 million in 2021 for estate, gift, and GST (generation skipping transfer) taxes. As it now stands, individuals can transfer up to $11.7 million of assets during their lives and at the time of death without having to pay federal estate, gift, or GST taxes. Married couples can transfer twice that amount.
While this federal exemption is already scheduled to revert to $6 million on January 1, 2026, the word from Washington is that it could revert to $6 million (or even lower) much earlier than that. A lower Estate Tax exemption means your Estate could end up paying major taxes upon your passing in what amounts to a “death tax” for anyone who owns more property than the Estate Tax exemption.
There’s also a possibility that any changes could be made retroactive to the beginning of the year in which those changes are enacted. We’re out of the woods for 2020. . . but the implications for 2021 remain unknown.
Elimination of Basis Step-Up for Inherited Property—When someone inherits an asset after the benefactor dies, that asset is often valued with what is called a “stepped-up basis”to avoid paying capital gains taxes. This strategy is often applied to real estate, securities, and practically anything of significant value.
For example, let’s say you bought a house in the 1970s for $120,000 and its current fair market value is $850,000. Upon your passing, it’s inherited by your children and sold immediately. Under the existing basis step-up law for inherited property, your heirs would pay ZERO capital gains because any gains would be wiped out by using the current fair market value as the basis (or purchase price).
Under anticipated changes, however, if the basis step-up is eliminated, under the same scenario described above your heirs would pay capital gains taxes on $730,000 (the current fair market value of $850,000 minus the original purchase price of $120,000), or about $225,000!
Cleary, if the reports from Washington D.C. are true that the Biden administration intends to eliminate or severely curtail the basis step-up practice, people inheriting assets could face major tax consequences. The significance of this change for everyone cannot be overstated. It would apply to all current homeowners as well as anyone who will inherit real estate from another family member.
What Should You Do?
First of all, don’t panic. Only Prop 19 has gone into effect. Discussions of changes to federal estate tax exemptions and basis step-up rules are merely speculative at this time. No one is sure if or when these changes might take place, whether they’ll be retroactive, or if there will be others. However, it is important to note that the above changes were campaigned on by our current President. Additionally, the Democratic party is in complete control of the Senate, House of Representatives, and the Oval office. This means that whatever changes the Democratic party is in favor of, they will likely be able to push into law.
For those concerned, we recommend you work with qualified, experienced Estate Planning attorneys, such as those at Shoup Legal, to explore your options and plan accordingly. Solutions, of course, will be unique for each family.
- Is your current Estate Plan up to the test?
- Under Prop 19’s new tax rules, will your children be able to afford to keep the property in the family?
- What assets do you now hold? What are their values?
- What plans do you have to acquire more assets or sell those you now possess?
The typical Estate Plans most families rely on will not address the above significant changes in law should they occur. It’s important to sit down with your Estate Planning attorney and strategize how best to address these changes.
If you have questions about how changes in state and federal tax laws might affect your Estate Plan, we can help. The attorneys at Shoup Legal are experts at Estate Planning and helping clients secure their assets and protect their heirs. Contact us at (951) 445-4114 or email us at firstname.lastname@example.org to discuss your unique situation today.