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2021 Tax Law Changes to Estate Plans

2021 Tax Law Changes That Affect Estate Planning

The recent passage of new laws will affect the longstanding norms of estate planning. 

Please be advised that the following  have been affected by the recent passage of new laws:

(1) Elimination of certain rules related to parent-child real property transfers (Prop 19);

(2) Changes to retirement plans (i.e., 401 (k), 403(b), IRAs) [The SECURE Act]; and

(3) Changes to the federal gift and estate tax exemption

Prop 19: Changes to Parent-Child Property Tax Exclusions

The passage of Proposition 19 in California eliminates the preservation of low property tax rates once afforded to parents and children transferring real property in California.


Prior to February 16, 2021, California real property owners can transfer their primary residence of any value to their children with the children retaining the parents' property tax rate. In addition, parents could transfer up to $1 million of assessed value of their other California real property to their children with the children receiving the parents' property tax rate. This is commonly referred to as the "parent-child" exemption. Similar rules applied to certain transfers between grandparents and grandchildren (e.g., when the grandchildren were orphaned) and for transfers from children to parents.


•           Starting February 16. 2021, the parent-child exclusion will only apply if the following factors are true:

1.         The property is the parent's primary residence;

2.         The property becomes the child's primary residence (with the child claiming the homeowner's exemption for property taxes) within one year of the transfer; and

3.         The fair market value of the property is less than the assessed value plus $1 million. If the fair market value of the property is greater than the current assessed value plus $1 million, then the property is subject to a partial reassessment for the value greater than assessed value plus $1 million.


•           The parent-child exclusion also will still apply for certain family farms.

•           Starting February 16, 2021, real properties that are not the parent's (and then child's) primary residence (e.g., a vacation home, rental home or commercial property) will no longer qualify for the parent-child exemption and property taxes will be reassessed to the current fair market value at the time of the transfer.


            Before rushing to transfer a property to your child (or to an irrevocable trust for your child), however, careful consideration should be given to the property tax advantage of transferring a property versus the potential disadvantages of such a gift. For example, by gifting real property during your lifetime, your child would have the same income tax cost basis that you have (i.e., "carry over" income tax cost basis). If your child then sold the property during his or her lifetime, your child may be liable for huge capital gains. In contrast, if your child inherits the property on your death, then your child's income tax cost basis becomes the fair market value on your death, which often can be an enormous income tax benefit if your child then sells the property during his or her lifetime. Also, for rental property, this so-called "stepped up cost basis" oftentimes affords beneficial income tax deductions. Finally, although only time will tell, it's possible that a new proposition will be placed on the ballot to reinstate the current, popular parent-child exclusion.


            If what you read above causes you concern, be mindful that you only have until next February 16th to transfer properties by recording deeds to or for your child (and, in some cases, children of a deceased child) without property taxes increasing for your child under the current parent-child exclusion rules.


            In addition, Proposition 19 expands special rules for eligible real property owners who wish to transfer their property tax rate when moving to another home within California, with that effective date starting April 1, 2021.


The SECURE ACT - Changes to Retirement Plans

On January I, 2020, the SECURE Act made several changes targeted at retirement rules. Most relevant to estate planning is that it eliminated the "stretch out" rules for nonspousal beneficiaries inheriting individual retirement accounts, such as IRA, 401 (k), and 403(b) plans, as follows:


·       Prior to January 1, 2020, nonspousal beneficiaries inheriting these plans could elect to take only RMDs over their life expectancy. This was commonly referred to as an "inherited" or "stretch" IRA.

·       After January 1, 2020, plan beneficiaries who do not fall under one of the following four exceptions must cash out the IRA or 401(k) within 10 years of the account holder's death, regardless of the income tax consequences. Now, only the following categories of beneficiaries may elect the stretch provisions:


1.     Surviving spouse of the deceased account owner;

2.     Minor children of the deceased account owner (but only until they turn age 18- after age 18, the deceased account owner's children will have 10 years to liquidate the inherited account);

3.     The chronically ill and disabled (including a special needs trust for a disabled beneficiary);

4.     Beneficiaries who are not more than 10 years younger than the account owner (e.g., the 75-year old deceased account owner's 66-year old sibling).


·       The SECURE Act does not impact beneficiaries who were already taking required minimum distributions from inherited accounts prior to January 1, 2020.


            Due to these changes, you should revisit who you named as beneficiaries to your retirement plans, including reviewing the following:


•           If your current living trust plan includes a conduit trust, you may wish to review the drafting of that trust with your estate planning attorney to understand the implications of the SECURE Act.

•           If your estate plan includes a special needs trust or a disabled beneficiary, you may wish to revisit how your retirement plans can be used for that beneficiary in light of the SECURE Act.

•           If your estate plan includes leaving money to charities, you should confer with your tax advisor regarding naming charities as beneficiaries of your retirement plans. Because charities do not pay income taxes, the full amount of the retirement account would directly benefit the charity of your choice.


Changes to Federal Estate and Gift Tax Exemptions 

The estate and gift tax exemption for 2021 is $11,700,000 per person - up from $11,580,000 in 2020. That means an individual could leave $11,700,000 to heirs and pay no federal estate or gift tax, while a married couple could shield $23,400,000. There is a flat 40% estate tax rate on the taxable estate on death. The current estate tax exemption is set to expire at sunset December 31, 2025, at which time it will revert to the pre-2018 exemption level of $5 million (indexed for inflation) for an individual taxpayer, unless Congress and the President enact tax laws to change that result.


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