by Robert A. Briskin
Federal taxes, including taxes that effect estate planning, may again be changed by Congress after the November 2020 election. Both Republicans and Democrats have spoken about reforming the federal tax laws after the election. Additionally, there have been proposals in California (which have not yet become law) to increase California’s income tax rates on high earners, to modify the property tax laws, and to impose a new type of tax on a California resident’s wealth.
After the 2016 election, under the Tax Cuts and Jobs Act of 2017, the unified federal gift and estate tax exclusion amount (known as the “Gift and Estate Tax Exemption”) increased so that in 2020 (after considering adjustments for inflation) it is now $11,580,000 per person (or a total of $23,160,000 for a married couple). This exemption can be utilized by clients for lifetime gifts or at the client’s death to leave assets to their families and beneficiaries. Currently, the estate and gift tax for amounts over this exemption (given during lifetime or at death) are subject to a top marginal 40% federal tax rate. For assets that clients leave to their grandchildren or that are left in a manner that “skips a generation” there is an additional generation-skipping tax of 40% (plus a generation-skipping tax exemption that applies to such transfers which is the same amount as the current Gift and Estate Tax Exemption of $11,580,000 per person).
Under current tax laws, these exemptions for both the federal estate and gift taxes and for the generation-skipping tax, are scheduled to revert to their prior 2018 levels in January 2026.
This Gift and Estate Tax Exemption amount is currently the highest it has ever been in history. Clients need to be aware that after this upcoming November election, Congress may choose to enact tax legislation to have this Gift and Estate Tax Exemption amount revert to its prior levels (or an even lower amount) sooner than January 2026, and that estate and gift tax rates may be increased.
Furthermore, there have been discussions to eliminate the current step-up in income tax basis of assets at death under Section 1014. The step-up in tax basis rule has been a part of federal tax law since the inception of the U.S. income tax, although for a brief time period in the late 1970s there was a temporary carryover of an asset’s income tax basis at death. A repeal of the step-up in income tax basis tax rule would effectively cause an income tax increase to those persons who inherit property at a family member’s death.
Even if the current $11,580,000 Gift and Estate Tax Exemption is reduced by Congress in the future, gifts made prior to its reduction will still be recognized at death under current tax laws. In other words, the Treasury Regulations specifically state that there is no “clawback” of the previously used exemption when the donor dies, even if that donor has made gifts previously in excess of the Gift and Estate Tax Exemption amount in effect at that donor’s death.
In addition to the Gift and Estate Tax Exemption, each individual in 2020 may gift $15,000 per calendar year to any number of donees without incurring a gift tax. Thus, under this annual gift tax exclusion, a married couple may gift up to $30,000 per year per donee, gift tax-free. Under current law this $15,000 amount increases for inflation. Additionally, amounts may be given gift tax-free for a donee’s tuition and medical expenses.
Clients who want to take advantage of the current high Gift and Estate Tax Exemption amount and lower transfer tax rates should be proactive and take action now to transfer their wealth to lower family generations levels. Even though any federal tax legislation under a new Congress is likely not to be enacted until February or March 2021 at the earliest, Congress could make the effective date of such a tax change back to January 1, 2021. In addition, many estate planning transfers and planning techniques require valuation appraisals, and enough time may be needed to obtain such appraisals.
Clients who make gifts of significant wealth to family members not only take advantage of the current high Gift and Estate Tax Exemption amount and the current low gift and estate tax rates, but also can shift future appreciation and taxable income to those family members. Sophisticated estate planning methods can take advantage of the current low interest rates. For example, the September 2020 long term AFR interest rate is 1%, and the Grantor Retained Annuity Trust (known as a “GRAT”) has a favorable low interest rate of 0.4% for September 2020. Using these low interest rates allows clients to use irrevocable “grantor” trusts to transfer assets gift tax-free to younger generations. Under a grantor trust (sometimes known as a “defective income trust”) all of the trust’s taxable income and deductions flow through to the parents for income tax purposes, but the appreciation in those grantor trust assets goes gift and estate tax-free to the children and grandchildren. Grantor trusts are effective tax planning devices since the parents continue to pay the income taxes on the income, business earnings and dividends that, in fact, go to the client’s children and grandchildren (resulting in the children and grandchildren receiving more assets).
Parents transferring assets today to lower level family members not only removes those assets from the parents’ taxable estate for federal gift and estate tax purposes, but any of those assets’ subsequent income or appreciation inures to the benefit of the clients’ children and grandchildren. Gifting and selling assets to irrevocable trusts (grantor trusts and other types of trusts) for children and grandchildren can also have the added advantage of shielding those assets from the children’s and grandchildren’s creditors and protecting those assets in the event of divorce.
Currently, California taxpayers in the highest tax bracket of 13.3% pay the highest income tax rate of any state (California does not have a lower capital gains tax). Assembly Bill 1253 which is now pending in the California state legislature would increase California’s income tax rates even higher. Assembly Bill 1253’s proposal is to tax higher earning California taxpayers by imposing an additional income tax as follows: 1% for taxable incomes over $1,181,484; 3% for taxable incomes over $2,362,968; and 3.5% for taxable incomes over $5,907,420. Thus, the wealthiest California taxpayers would pay a California income tax of 14.3% on their taxable incomes over $1,181,484 and 16.8% on their taxable incomes over $5.907 million. As an example, a California resident earning more than $5.907 million would pay a combined 53.8% tax rate of federal and California income taxes at this highest tax bracket. Additionally, there is the current 3.8% federal net investment income tax under the Medicare rules. Under this proposed California tax legislation in its current form these increased California income tax rates would apply retroactively to January 1, 2020.
If these proposed high California state income tax rates are enacted into law then they will have an especially detrimental tax effect since current federal income tax rules makes state income taxes nondeductible above a $10,000 cap amount.
There was introduced into the California’s legislature a new proposal to impose a tax on the amount of a California resident’s wealth. California currently has no state level estate or inheritance tax, which has been the case since June 1982 when the California state inheritance tax was repealed by a ballot measure. However, in recent years legislation has been introduced (which has never been passed) into the California legislature to attempt to reenact the California inheritance tax. Now, additionally, a new proposed wealth tax (to apply to California residents while alive) was introduced on August 13, 2020 into the California State Assembly (but has not been passed) to impose a 0.4% annual tax on a resident’s worldwide net worth over $30 million (or $15 million for married taxpayers filing separately). This wealth tax is aimed at wealthy California residents and is intended to be an annual tax based upon a person’s net worth. Under this proposed wealth tax once a person becomes a resident of California, if that person then later leaves the state that person will still have this wealth tax imposed on a fraction of their wealth in excess of $30 million for up to ten (10) years after leaving California (note that there are federal constitutional issues as to whether such a wealth tax would be enforceable if it were ever enacted into law by the State of California). If this wealth tax were enacted, it would discourage wealthy persons from remaining residents of California and would discourage wealthy persons and businesses from moving into the State of California.
Currently, under Proposition 13 real property assessed values for purposes of property taxes are limited to increases of no more than 2% each year, except where there is a “change of ownership” of that property. A “change of ownership” can trigger a reassessment of the real property unless there is a specific property tax exemption that applies.
One of the current California property tax exemptions preventing a change of ownership is where a principal residence is transferred between parents and their children. Additionally, currently there is an exemption for $1 million of assessed value of real property being transferred between a parent and their children. These parent-child property tax exemptions have proven invaluable as estate planning tools, enabling clients to transfer their California real estate (such as their principal residence) to their children without having that property reassessed for property tax purposes. However, other than the parent’s principal residence, California Proposition 19 on the November 2020 ballot proposes to eliminate the $1 million exemption for parents transferring other properties to their children. Additionally, Proposition 19, if passed, would place limitations on the parent-child exemption for transfers of a principal residence between parents and children, by limiting this exemption to the amount of $1 million plus the amount of that residence’s assessed value on the date of transfer (this $1 million limit amount would be adjusted annually by an index rate). Furthermore, Proposition 19, if passed by the voters, would also require that the transferee child continue to use that residence as their principal residence in order to be entitled to apply this exemption from a change of ownership.
Thus, if Proposition 19 passes it will have a negative effect on a parent’s ability to transfer their California real estate to their children and avoid reassessment of that property for property tax purposes. Clients could consider transferring now in 2020 their real estate to their children in order to avoid proposed Proposition 19’s restrictions.
Additionally, also on the November 2020 ballot is Proposition 15, which if passed, would produce a split-roll for California real property effective January 1, 2022. Proposition 15 would require that commercial and industrial property, and vacant land not zoned for residential use and not used for commercial agricultural production, to be reassessed every three years to that property’s full market value.
© 2020, Law Offices of Robert A. Briskin, a Prof. Corp. All rights reserved.
Nothing in this Newsletter shall be deemed legal or tax advice to any person or as to any transaction. No attorney-client relationship is formed by this Newsletter. Please feel free to contact Robert A. Briskin at the contact information below if you wish to discuss any of the items contained in this Newsletter.
Law Offices of Robert A. Briskin, a Prof. Corp
Robert A. Briskin is a Certified Specialist in Taxation Law by the State Bar of California. He is a frequent speaker before accounting groups, Bar groups and other professional associations. He is an AV rated attorney by Martindale-Hubbell.
Robert A. BriskinLaw Offices of Robert A. Briskin
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