Direction of estate taxes among top advisor concerns

Direction of estate taxes among top advisor concerns

Most financial professionals are closely monitoring tax policy developments on Capitol Hill. With the new administration and Congress, it is not yet clear what tax proposals will be introduced on the legislative agenda this year.

In Putnam’s recent series of webcasts and conversations with financial professionals across the country, we found that most advisors are concerned higher taxes could be in store later this year. Recently, we highlighted common questions financial advisors have asked regarding the outlook for potential tax policy changes this year. In this post, we continue this theme by addressing additional questions we’ve received, for instance the outlook on estate and gift taxes.

1. There’s been talk of increasing taxes on gifts and estates, what’s the likelihood that we see movement on this area in 2021?

While there is strong support among certain members of the Democratic caucus in Congress to raise transfer taxes, it’s unclear whether it would garner enough support needed to pass the Senate. There has been discussion on rolling back the Trump-era changes to a $5.5 million lifetime exclusion for gifts and estates (indexed for inflation) from its current level of $11.7 million per individual. Progressive lawmakers such as Senator Bernie Sanders (I-VT) want to go a step further and reduce the exclusion to $3.5 million for estates, and $1 million for gifts. These are levels that we saw in 2009.

Assuming that changes to gift and estate tax law would not receive Republican support in the Senate, the Democrats would likely need to use the reconciliation process. In the event of a budget reconciliation bill, Democrats could not afford to lose one vote in the Senate. In the past, more moderate Senate Democrats (Joe Manchin D-WV, Kyrsten Sinema D-AZ) have voiced opposition to the federal estate tax. Also, reducing the lifetime exclusion amount may not raise enough significant revenue to offset other spending priorities.* For these reasons we believe that changes to estate and gift tax laws may be less likely in the short-term but could be targeted by lawmakers seeking to address wealth inequality concerns.

2. The Biden team has mentioned increasing payroll taxes on higher earners, what’s the likelihood of that occurring later this year?

During the campaign, there was a proposal floated to apply Social Security payroll taxes (again) once income from wages exceed $400,000. Presumably, this would apply to both the employer and employee portions of the tax, but the proposal was not clear. For 2021, the Social Security wage base is $142,800. If the $400,000 threshold applied that would mean the 6.2% employee payroll tax would apply for the first $142,800 of wages, and then again for any wages exceeding $400,000. This would leave a type of “donut hole” between the two figures where the payroll tax would not apply.

Assuming that this proposal would not receive Republican support in the Senate means that this provision would have to be pursued through budget reconciliation. However, Senate rules prohibit making changes to the Social Security system by using the reconciliation process. Whether this provision would violate Senate rules — like the recent minimum wage proposal — may be a matter of interpretation. Democrats could also take steps to disregard the existing rules governing reconciliation, however, moderate Democrats in the Senate generally regard this as controversial. Consequently, we think that this payroll tax proposal is not likely to emerge in 2021. However, we do believe a meaningful increase in the Social Security wage base is likely inevitable at some point when lawmakers eventually address trust fund solvency issues.

3.  If Congress does pursue tax changes later this year, is there a chance that tax increases could be applied retroactively to the beginning of 2021?

While there is historical precedent for tax law changes being applied retroactively, we believe that this is a possible, but not likely scenario. There has not been a meaningful retroactive tax increase since 1993, when the maximum estate tax rate was increased from 50% to 55% in August and applied retroactively to the beginning of 1993. Under the Bush administration, retroactive tax changes signed into law in June of 2001 actually benefitted taxpayers by reducing the tax rate on the lowest marginal tax bracket, retroactive to the beginning of 2001.

In particular, some clients we’ve spoken to recently are concerned that the capital gains tax rate could be applied retroactively, thereby eliminating the opportunity to plan for such an increase. If we did see legislation including tax increases signed into law later in 2021, we believe that changes would become effective beginning in 2022. Beginning with tax year 2013 was the last time we saw an increase in capital gains taxation for some taxpayers. First, passage of the Affordable Care Act (ACA) in March 2010 imposed a 3.8% surtax on net investment income, including capital gains. The 3.8% surtax became effective beginning in 2013, so investors had time to adjust. Additionally, the American Taxpayer Relief Act (ATR) was signed into law on New Year’s Day in 2013 and raised the maximum tax rate on long-term capital gains from 15% to 20% effective for the beginning of 2013.

Tax efficiency

While some of these tax proposals may not emerge until later in the year, investors can benefit by reviewing their current financial plan with a professional advisor to make sure they are taking advantage of tax-efficient strategies under the current tax rules. Consider the impact of potential tax changes on estate and gift planning, a key component of a comprehensive financial plan. Read Putnam’s “A closer look at the current estate and gifting tax rules,” to begin a review.

*Per the Congressional Budget Office (CBO) federal estate and gift taxes accounted for $23 billion in revenue during FY 2017. This was the last year before the Tax Cuts and Jobs Act doubled the lifetime exclusion amount. For 2020, CBO estimates $18 billion in revenue generated at the existing estate/gift exclusion level.


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