As a follow-up to her presentation at the 2020 PICPA Tax Con, Rachel Kieser, shareholder with Drucker & Scaccetti in Philadelphia, provides an update on individual federal income and estate tax issues for the upcoming year, including the impact President Joe Biden’s tax plans will have on estate taxes, how the CARES Act will affect 2020 tax filings, COVID-19’s effect on gift tax planning, and more.

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By: Bill Hayes, Pennsylvania CPA Journal Managing Editor

Podcast Transcript

As a follow-up to her presentation at the 2020 PICPA Tax Con, we are talking today with Rachel Kieser, CPA, shareholder for Drucker & Scaccetti in Philadelphia, for an update on individual income and estate taxes. She'll discuss the CARES Act's impact on 2020 tax filings, COVID's impact on gift tax planning, and much more.

As we take a look at it, what were some major changes to retirement planning provided under the SECURE Act, which was passed in 2019?

[Kieser] There were several changes, but I think there are three major ones that are worth noting. The first one would be the loss of the stretch IRA. I think that's the one that most people were concerned about when the SECURE Act was passed at the end of 2019. Previously, people could put money in their retirement plans and leave them in there to their grandchildren. Basically, what would happen is once they would inherit the IRA, it would be taken out over the life of that potentially young individual. But now that stretch IRA has gone away and it's been replaced with what is being called the 10-year rule. So now, spouses are anyone besides a spouse and disabled person, chronically ill or a minor child. There's exceptions for those individuals, but, everyone else, they must take the funds out of that IRA, including Roth IRAs, by the 10th year, from the passing of the person that owned the account.

So that was huge. A lot of people have been ... they had done planning. I know we had clients that had done planning that changed the beneficiaries to their grandchildren and then all of a sudden that planning was obsolete at that point. A lot of people are changing their beneficiary designations because of that new law. Another major change in the SECURE Act was they changed the beginning age for the required minimum distribution. Previously, you had to start your RMDs when you turned 70 and a half. Now that age has been increased to 72. Maybe they think people are working longer so let's not make them start at 70 and a half anymore.

Another major change was that now people can contribute to their IRAs past age 72 as long as the person is working. Of course, you still need an earned income in order to contribute to the IRA, but you can do so past age 72. Prior to the SECURE act, you were limited by your age on when you could continue to contribute.

It's funny, because we talk about the SECURE Act that was passed in 2019 and here we're already at 2021. Lot of things have happened in that year, including the new presidential administration: President Joe Biden. Could you provide an overview of President Biden's proposed tax laws and what they could mean for estate taxes?

[Kieser] I'll start with the individual income tax as I think some of the items would impact someone's estate plans. They're looking at capital gains rates and things like that. The proposals, which I don't think we had great complete information from Biden's campaign, there are certain things that are left unanswered, but from what we do know is that he proposed to increase the top tax rates from 37% back to the previous 39.6% rate, for taxpayers with taxable income over $400,000. We don't know if that's $400,000 for a couple, or if it's $400,000 for a single person. Is it $800,000 for a married couple? That's the unanswered question there, but he does want to change that top rate. For the capital gains rate, he has proposed to make the rate the top tax rate, because this is for people with a million dollars or more of income.

He's proposing that capital gain rate instead of 20%, plus the net income tax and then investment income tax of 3.8, so 23.8. It would now be 39.6, so that's another proposal. Related to payroll taxes, he's proposed to tax wages and self-employment income over $400,000. Right now, we know your Social Security wage, the tax is capped. For 2021, it's about $143,000. They're talking about what would be a donut hole between $143,000 to $400,000, you won't pay Social Security tax on that, but then anything over $400,000, you would.

Related to deductions, he has proposed a couple of limitations on itemized deductions, but one that would benefit many people would be the repeal of the $10,000 SALT limitation and I actually just saw something this morning, where they are thinking about doing that pretty quickly once the new administration takes office, that's the state and local income tax limitations.

Then a couple of other things for over $400,000, he's thinking about phasing out the qualified business income deduction, that 20% deduction that was under the Tax Cuts and Jobs Act for pass-through income, and then also eliminating or limiting the 1031 exchange deferrals for those with $400,000 or more.

Then, for estate tax, there's two items that he has proposed that could have potential large impacts on certain estates or certain taxpayers with large estates. The main proposal is the reduction in the estate tax exemption. Right now, the estate exemption is $10 million adjusted for inflation per person, so for 2021, it's $11.7 million. For a married couple, that means $23 plus million dollars can be transferred out of their estate without gift or estate tax. That's to revert under current law in 2026, but the Biden administration has signaled that they would potentially revert it back sooner. I think that the House Democrats at one point did present a bill where it was reduced to $3.5 million, so there is some discussion that it could go down further.

The other item on the estate taxes that he has proposed to eliminate is the basis step-up. We know that under current law, when someone passes away, their assets are revalued to the fair market value at death, and then their beneficiaries inherit that basis as the fair market value. He's proposing to eliminate that step-up, so basically the beneficiary would inherit those built-in gains and would have to pay the capital gains tax when they sell the assets.

As we take a look at another pretty significant piece of legislation that had taken place – the CARES Act – what changes from the CARES Act are we expecting could impact 2020 tax filings?

[Kieser] There was a lot in the CARES Act and I know we heard a lot about the PPP and certainly that will impact businesses and flow-through entities, but I think there's three items that will really specifically impact individual tax returns. The first being the stimulus checks. I know that's probably on a lot of people's minds and their clients have been getting these checks in the last couple of weeks too. Basically, people got checks in the summer last year – spring, summer. When taxpayers go to file their returns this year, there's going to be what's called a recovery rebate credit on their return. The checks that they got last year were kind of like an advance of that credit. If they got the money already, they're not going to get another credit now but, if for some reason they didn't get the check because their 2018 or 2019 income was too high, but now with their 2020 income, they would qualify, get that credit. I'm sure there'll be an extra form or something with the tax return to handle that.

The other thing would be charitable contribution deductions. There are a couple of changes there, the one being for non-itemizers. Under the CARES Act, they allowed for a one-time, non-itemizer deduction. Typically, if you don't itemize, you don't really get a benefit for charitable contributions that you make because you're not increasing your deductions for the charity, but they're allowing above-the-line deduction for up to $300, just for 2020. I believe it was just extended for 2021, but that'll help a little bit for those people that don't typically itemize.

Then, for larger deductions, the CARES Act increased the AGI limitation for cash contributions. Typically, someone's cash contribution would be limited to 60% of their adjusted gross income. For 2020, they increased it to a hundred percent, but it has to be for cash contributions, and it has to be directly to a public charity, so one can't just donate to their private foundation or a donor-advised fund. Those limits still apply for those two things.

Lastly, there's a potential opportunity related to the 2020 filing. If someone has a net operating loss with their 2020 tax return, they'll be eligible to carry that NOL, that net operating loss, back five years under the CARES Act and claim a refund for taxes they paid in prior years. So if it's a 2020 year, you'd go back to 2015. If you paid tax in that year, you can offset your income in 2015 with that net operating loss. You could potentially get refunds for '15, '16, '17, '18, and '19, depending on the level of your NOL.

How has COVID-19 affected federal estate and gift tax?

[Kieser] I think from a non-technical standpoint, it made people focus more on their estate plan. I think COVID-19 may have caused people to think more about their mortality, what would happen to my assets if I were to pass away unexpectedly, if I got sick or incapacitated, how would my family be taken care of? If I don't have a will, would they have to jump into my shoes and take care of a messy estate? I think, from that perspective, it really made people think more about getting their ducks in a row. I know the estate attorneys were very busy this year from estate planning for use exemption, but also people were updating their wills. If they had them updated for 10 years, maybe there's new kids or their situation has changed. I think from a non-technical tax perspective, it really made people focus more.

The other thing is that for valuations, for estate planning purposes, we've seen the markets rebound a lot since March, but in certain industries and certainly in the spring, it was possible, and I think it's still possible, to obtain low valuations for closely held businesses. If taxpayers are looking to transfer interests, like nonvoting interest in a company that they run, they can get low valuations and transfer more out of their estate and using less exemption because they're leveraging that low valuation. I think we'll be seeing that a little bit. I think it'll continue, especially in certain industries – restaurants and industries that have been more impacted by COVID – that haven't been able to work at home the whole time.

In an overall sense, what strategies should those individuals who work on estate tax consider in 2021?

[Kieser] Going back to the decrease in estate tax exemption we talked about under the new administration, right now there exists this what we're calling a “use it or lose it exemption,” so if the ... the estate tax exemption will revert back to $5 million, whether it's now or 2026. So that delta between the current $11.7 million and that $5 million adjusted for inflation, whatever number that may be, that extra $5 to $6 million is really use it or lose it because the IRS has stated that they will not claw back gifts made during this time of higher exemption. It might be an opportune time to make gifts to family members or trusts in order to use that exemption.

We had several clients before the end of the year making gifts because they're going to be subject to estate tax, regardless of whatever the exemption is. You have to make sure they have the bandwidth to make those gifts, obviously, but if you've been thinking about doing those gifts, it's probably a good time. Another reason that it's a good time for estate planning is that interest rates are really low. The applicable federal rate and the Section 7520 rates, those are used for estate planning purposes, they are ticking up a bit, but they're still low and low interest rate environments are great opportunities for making interfamily loans to family members, or making gifts to grantor-retained annuity trusts as well as charitable lead annuity trusts, depending on what your goals are for your estate.

Then it's also advantageous for sales to intentionally defect to grantor trust because the trust would have to pay back a lower amount of interest to the grantor, leaving more inside the trust to go to future generations. Then again, valuations may still be low in certain industries like I said before, so I think there will still be some ... even though there was a big push in 2020 to do estate planning, there's still many things that people can do in 2021.