Will the estate tax be an unwelcome 'comebacker'?
September 1, 2020
Baseball fans love to nickname things. A home run can be a simple “homer” but it can also be a “tater,” a “dinger,” a “jack” or “going yard”. In fact, there are dozens of nicknames for the baseball fan’s favorite play.
One thing nobody in baseball likes to see, however, is a “comebacker”. That’s when the ball is hit directly back at the pitcher. Because the pitcher is off-balance after throwing the ball, he may not have a chance to get his glove up and protect himself, so a comebacker can do some serious injury.
So a comebacker is something coming right back at you, before you’re ready, that can really hurt. For me, the comebacker is the federal estate tax.
When I was a young attorney, the federal estate tax was a huge deal for any planner. It applied to any estate more than $600,000, and the tax rate quickly climbed up to 55% for a lot of estates. You don’t have to be a math whiz to realize that 55% means that Uncle Sam is getting more of what you worked for, than your family is.
But elections matter, as someone once said, and eventually George W. Bush was elected President, with a Republican House and a split Senate. And one of the things they did, was raise the estate tax exemption. It immediately jumped up to $1 million, and then automatically climbed every few years after that. Eventually there were other elections, and bills, and compromises, and today the estate tax rate is 40%, which is still pretty hefty. But the exempt amount is $11.8 million, which means that very few people have to worry about that estate tax rate at all. At the moment, less than one-tenth of 1% of the estates of people who die, have to pay any federal estate tax.
There is a little bit of a catch. If they don’t manage to extend the current exemption, at the beginning of 2026 the exempt amount will drop by about half, so anything over $6 million will be taxed. And I have been keeping an eye on that, and occasionally recommending a few preventive measures to clients, but nothing too serious. If we get to the last few months of 2025 and it doesn’t look like they’re about to reach a compromise, I might have to recommend that some of my wealthier clients make gifts of a substantial part of their assets to their heirs, to avoid the automatic drop. But even then, that would be a pretty small portion of my clientele.
So why worry about the estate tax? We are five and a half years away from that automatic decrease, and there is plenty of time to adjust things before then.
Except that I watch the news (when it doesn’t depress me too much) and one of our major political parties is talking very seriously about substantial tax increases if they get into power in this next election. The estate tax is one of the things they really have their eye on.
That’s a comebacker for me. I thought I had until 2026 to get turned back around and get my glove up, and here comes a line drive right at my head.
Come the beginning of next year, we could very well be in a position of having to adjust a lot of estate plans very quickly, to account for a much lower estate tax exemption. But on top of that, other taxes may be increased as well, and that makes the planning even more complicated.
For instance, one of the candidates is very serious about not only increasing the capital gains tax rate, but also taking away a juicy little loophole called the “step up in basis on death”. If that happens, a lot of people are going to want to sell their appreciated stocks or properties as quickly as possible, to pay the tax while it is still a relatively low 15% (for most people).
And let’s not forget the income tax, which applies when someone inherits an IRA, 401(k), TSP, or similar type of tax-deferred account. When candidates talk about increasing income taxes on “millionaires and billionaires” who make hundreds of thousands of dollars each year, they are actually including (without saying so) a lot of people who inherit an IRA, pull the whole thing out of the IRA account at once, and for probably the only time in their lives have several hundred thousand dollars of income. They are going to get hit with a wallop of a tax bill, because they will be taxed as if they make that kind of income every year.
Pitchers have to learn to get straightened back up quickly, and get that glove up to protect themselves. Come January, estate planners may have to do something which is metaphorically similar.
Or our clients will be looking at another nickname for a home run: “kiss it goodbye”.
Kenneth Kirk is an Anchorage estate planning lawyer. Nothing in this article should be taken as legal advice for a specific situation; for specific advice you should consult a professional who can take all the facts into account. Not a professional baseball player, a professional estate planner.