Estate Tax and Prop 19 Changes That May Impact You

This addresses important recent developments relating to gift and estate tax planning, California property tax matters, and aspects of the recently implemented SECURE Act affecting retirement planning. Although we should always discuss any significant personal, family or financial changes you have experienced that may necessitate an update to your estate plan, changes in the areas outlined may also provide advantages for revisiting your estate plan.

Estate and Gift Tax Exemption

The potential for a decrease in the federal gift and estate tax exclusion amount means that some may want to make gifts of property now while the exemption rates are at a historic high. If you are an individual with more than $5 million of assets, or a couple with $10 million of assets jointly, or own less than that but you believe the exemption amount may be reduced further as discussed below, then you may wish to discuss gifting as a strategy to reduce your estate tax liability with our firm, your CPA or your financial advisor before year end.

The current federal gift and estate tax exclusion amount, which is the amount that an individual may pass on to others during lifetime or at death without incurring gift or estate tax, is $11.58 million per person in 2020 ($23.16 million for a married couple). This estate tax amount may soon be reduced in one of two ways: first, absent any legislative action, current laws provide that the exemption amount will be roughly halved after December 31, 2025, when it’s set to revert back to $5 million indexed for inflation, or second, potentially before then if new legislation is passed under the Biden presidency. Specifically, there is the potential that under the new presidency, the estate and gift tax exemption amount could return to “historical norms,” with exemption amounts in the range of $3.5 to $5 million per person and potentially higher tax rates.

The primary means of reducing potential estate tax liability as a hedge against the exemption amount decreasing is through gifting before the end of 2020. Although gifting the entire current exemption rate of $11.58 million per individual provides the most benefit, gifts of lesser amounts above the potential future exemption amount may still provide estate tax advantages.

California Proposition 19

If you own real property in California that you might give to or inherit from a family member (specifically, that may be transferred between parent and child and under some circumstances from grandparent to grandchild if the grandchild’s parents are deceased), you should consider the tax implications of California’s recently passed Proposition 19 and accordingly may wish to accelerate your plans and transfer the property now.

Currently, any change in ownership of real property in California causes reassessment of the property for tax purposes, unless there is an applicable exemption. There are currently exemptions for some transfers between parents and children and grandparents to grandchildren where their parents are deceased. Generally, currently exemptions (1) exclude from reassessment entirely a transfer of a parent’s primary residence to a child, with no cap on the value of the property transferred, and (2) exclude up to $1 million of assessed value of the transfer of a non-primary residence from parent to child.

Prop. 19 changes these exemption rules in significant ways. Under Prop. 19, a transfer of a primary residence to a child will only be exempt if the child also uses the residence as their primary residence, and the exclusion amount is capped at the parent’s assessed value plus $1 million, with the excess subject to reassessment. In addition, the transfer of a non-primary residence no longer carries the $1 million exemption from reassessment, and the entire value will be reassessed. Accordingly, due to the passage of Prop. 19, property owners must gift or sell certain real property to their family members before February 16, 2021 to take advantage of the current exemptions and avoid certain reassessment.

Prop. 19 also provides benefits for senior and disabled homeowners seeking to relocate and keep their current property tax basis for their primary residence, and provides benefits for those whose residency was affected by a wildfire or other natural disaster, the details of which are not discussed here but which should be reviewed if they are applicable to you.

SECURE Act

The Setting Every Community Up for Retirement Enhancement (“SECURE") Act was passed at the end of 2019 and became effective January 1 of 2020. The rules affect some significant aspects of retirement savings, and several of the most significant changes that relate to our estate planning work are summarized below.

One change made by the SECURE Act is that you can now contribute to a traditional IRA at any age, as long as you are earning income and have taxable compensation to contribute. This enables earners over 70 ½ to continue to take advantage of deferring income tax until the eventual withdrawal of the funds. Previously, you could not contribute to an IRA after the age that you were required to take distributions (then 70 ½). Additionally, the Act changed the age at which individuals are required to begin taking required minimum distributions from their IRAs from age 70 ½ to age 72.

The SECURE Act also limits the ability of some beneficiaries to "stretch" out the withdrawals from retirement accounts they inherit. Previously, IRAs left to children or certain other beneficiaries could be stretched out over the beneficiary’s life expectancy, essentially allowing the tax deferral of the IRA for a second lifetime. Now, under the Act, only spouses still have the option to stretch out the IRA over their remaining life expectancy. Generally, for any other beneficiary, inherited IRA funds must be distributed to the beneficiary within 10 years of the original account holder’s death. Minor children can defer the 10 year distribution period until they attain the age of majority, and the rule also provides exceptions for disabled beneficiaries and qualified special needs trusts. These new rules only apply to IRAs passed down by anyone who dies after December 31, 2019.

Lastly, the “kiddie tax” rate was adjusted to apply the rates of the minor’s parents once again. For several years previously, the estate and trust tax rate applied to the unearned income of minors, generally resulting in a higher tax rate.

Please contact us if you wish to schedule a consultation to discuss the impact of any of these changes on your estate plan.