Key 2025 Biden Budget Tax Reforms Impacting Your Estate Planning

President Biden’s 2025 budget proposal introduces several significant tax reforms that are particularly relevant for estate and tax planning. These changes could affect a wide range of taxpayers, including middle-class families and business owners. A clear understanding of these reforms is essential for effectively managing your estate and optimizing your tax strategies. We outline the main proposals and offer some guidance on steps you might consider.

Assessing the likelihood of the tax reforms becoming law and why you should pay attention now

Despite this, we cannot rule out the possibility that some parts of the proposal could pass during the negotiation processes in a divided Congress. The proposal might also suggest potential future changes, even if they don’t pass this time, signaling directions in which future tax policies could head. If the Democrats retain control of the Senate and regain control of the House in the upcoming elections, the probability of these reforms passing increases. Conversely, if Republicans maintain or strengthen their hold, particularly in the House, the proposed changes could be stalled or significantly altered.

Moreover, if any of these proposed changes are implemented, they are slated to start at the end of 2024 or upon enactment, providing a relatively narrow window for action. Tax laws can have profound and immediate impacts on estate planning and the transfer of wealth. This situation underscores the importance of being prepared and possibly accelerating certain estate planning actions before potential legal shifts occur.

Key Proposed Tax Changes

1. Corporate and Individual tax rates go up.

The 2025 Biden budget proposes notable changes to both corporate and individual tax rates. First, it seeks to raise the corporate income tax rate from 21% to 28%. This change would reverse some of the cuts made in previous tax legislation. The budget also targets high-income individuals with an increase in the top income tax rate from 37% to 39.6% for those earning more than $400,000 ($425,000 for married filing jointly).

In addition to these adjustments, the Net Investment Income Tax (NIIT) will be expanded. The NIIT currently applies an additional 3.8% tax on certain investment income above threshold amounts. Typically, this includes interests, dividends, capital gains, rental and royalty income, and certain passive activity income. The budget proposes to apply the NIIT to a broader base of income sources beyond just investment income, including all income derived from pass-through businesses (such as partnerships and S-corporations). It will also apply a higher rate of 5% for taxpayers with income over $400,000 ($500,000 for married filing jointly).

2. Capital gains will be taxed as ordinary income.

Under the proposed budget, capital gains are to be taxed as ordinary income for individuals earning above $1 million (or $500,000 for married filing separately). Typically, long-term capital gains (on assets held for more than a year) are taxed at lower rates than ordinary income, which can range from 0% to 20%, depending on your taxable income bracket.

3. Capital Gains Will Be Taxed on Gifts and Inheritances, Even Without a Sale.

What the Proposal Includes:

• Taxation of Unrealized Gains: Currently, capital gains taxes are generally due upon the sale of an asset when the gains are “realized.” However, the proposed changes would treat the transfer of property through a gift or at death as a taxable event. This means the increase in value of the property would be taxed, even if the property has not been sold.
• Exclusion Limits: Each individual can exclude up to $5 million of gains from these taxes, and this exclusion amount is indexed for inflation, allowing it to increase over time to reflect economic conditions.
• Portability Between Spouses: The exclusion is portable to the surviving spouse, effectively allowing a couple to exclude up to $10 million.
• Exemptions for Personal Items: Tangible personal property, like furnishings and personal effects, would be exempt from this tax, with the exception of collectibles.
• Home Sale Exclusion: The existing $250,000 per-person exclusion on gains from the sale of a primary home applies here too, and it’s also portable to the surviving spouse, making it a $500,000 exclusion per couple.

What this means:

• Higher Tax Burden: With capital gains taxed as ordinary income, as discussed previously, these changes could significantly increase the tax burden when gifts or inheritances are made.
• Importance of Liquidity: Liquidity, or access to cash, becomes a critical concern under this new tax structure. Families might need to have accessible funds to cover these taxes without having to sell inherited properties or businesses.
• Impact on Family Businesses: Many family-owned businesses could face challenges if they need to pay taxes on unrealized gains upon the death of an owner. In some cases, this could force families to sell the business if they can’t afford the tax payments.
• Potential Total Tax Rates: When these proposed taxes are combined with existing gift, estate and state taxes, the total tax burden on transferred assets could potentially reach 60%-70% of the asset values. This highlights the importance of proactive and strategic estate planning to manage potential tax impacts.

4. Capital Gains Will Be Taxed on Trust Contributions and Distributions, Even Without a Sale.

Under the new proposal, putting money into trusts or taking it out would now trigger an income tax, even if there was no profit or loss from a sale.

This means whenever you contribute to or distribute from a trust, you’ll need to calculate and report any increase or decrease in the value of the trust’s assets at the time you add or remove them from the trust. 

Exceptions for Grantor Trusts: The proposed rules include a narrow exception for distributions from grantor trusts to the grantor (or the trust creator) directly. It’s important to recognize that this exception has limited usefulness in estate planning because it does not apply to many grantor trusts that do not directly distribute assets back to the grantor. Grantor trusts are essential estate planning tools with the trust’s income considered as the grantor’s personal income for tax purposes. They serve multiple purposes, including transferring wealth to beneficiaries, reducing estate taxes, supporting charitable giving, and protecting assets.

What this means:

• Increased reporting burden: Under the new rules, every transaction involving a trust—whether adding or withdrawing assets—could require an appraisal to determine the gain or loss at the time of the transaction. This not only adds complexity but also increases the cost and administrative burden for taxpayers. Property appraisals, particularly for unique or non-liquid assets like real estate or art, can be costly and time-consuming. Taxpayers will need to ensure accurate reporting to avoid penalties, requiring more frequent engagement with tax professionals and appraisers.
• Challenges for the IRS: The IRS may face significant challenges in managing and enforcing these new reporting requirements. Tracking each transaction’s gain or loss until the accumulated capital gains reach the $5 million exemption threshold involves a substantial administrative load. There are concerns about whether the IRS has the capacity to effectively monitor and audit these transactions. Since the IRS cannot collect tax on these transactions until the accumulated capital gains exceed $5 million, there may be a considerable delay in actual tax revenue realization. To effectively handle the additional workload and ensure compliance with the new rules, the IRS will likely need more resources. 

5. Capital Gains Will Be Taxed Every 90 Years, Even If There Is No Sale and No Transfer of Ownership.

What if there is no sale or change of ownership for a long time, as we discussed previously with gifting or inheritance, or distribution from a trust? You will still be taxed. The new proposal includes a rule that every 90 years, properties held in trusts, partnerships, or other non-corporate entities must pay tax on any increase in value of the property, even if no actual sale or transfer of ownership has taken place.

What this means:

• The end of dynasty planning?: Dynasty planning involves multi-generational planning, allowing families to pass wealth down through several generations. This type of planning uses trusts and other financial structures to preserve assets over decades and even centuries. Every 90 years, assets like family estates or heirlooms would be assessed for tax based on their current market value. This could result in large tax bills. Families might face financial pressure to sell off assets to cover these taxes. This is especially challenging if the assets include things like land or art that the family intended to keep within the family for cultural or sentimental reasons.
  

6. Trust Assets Are Required to be Reported.

Under the current law, trusts are not required to report the value of assets held within them. The new proposal requires certain trusts to report both identifying information and estimated asset values.

• Thresholds for Reporting: The proposal requires trusts with assets exceeding $300,000 or those generating gross annual income over $10,000 to report their assets. These thresholds are indexed for inflation, meaning they could increase over time to reflect changes in the economy.
  
• Reporting Mechanism: The reporting would be done on the trust’s annual income tax return, or as otherwise provided by the Treasury.
• Information Required: Trusts would need to provide general information, including the name, address, and taxpayer identification number of each trustee and grantor. Additionally, they must report the general nature and estimated total value of the trust’s assets.

What this means:

• Increased Burden to administer Trusts: Trusts will need to undertake more rigorous accounting practices to meet these reporting requirements. This may involve higher costs for appraisal and administration.

7. There Will Be a New $50,000 Annual Tax-Free Gift Limit Per Donor.

• Potential for Reduced Flexibility: For many families, this change could reduce the flexibility they previously enjoyed in transferring wealth without tax implications. These families will need to be more strategic about how and when they make gifts, potentially requiring more detailed financial advice.
• Implications for Life Insurance Planning: This adjustment will particularly affect individuals who use gift-giving as a method for advanced estate planning, such as funding life insurance policies held in irrevocable trusts to provide liquidity for estate taxes after death. The new cap will limit the amount that can be gifted to pay premiums, directly affecting the strategy of maximizing liquidity.

8. C-corporations Provide Enhanced Tax Savings Opportunities for Family Businesses Under the New Capital Gains Rules

What This Means:

The Broad Impact of New Tax Proposals

What Families Can Do Now

• Continue Estate Planning Efforts: Families should not be discouraged from engaging in estate planning. The core purposes of estate planning—ensuring smooth transitions of assets, avoiding court involvement, maintaining privacy,  and asset protection against third-party claims—remain vital. Despite potential limits on tax planning benefits, these fundamental goals retain their importance.
• Plan with Flexibility: It’s crucial that estate plans are designed to be flexible. As tax laws and family circumstances change, having an adaptable plan will allow families to adjust without starting over from scratch. This flexibility will enable families to respond effectively to any legal shifts or personal changes.
• Act Sooner Rather Than Later: The proposed tax rules have not yet taken effect but are slated to become active upon enactment or by the end of this year. Therefore, if there are any necessary asset transfers planned, particularly those intended to optimize tax positions under the current law, it would be wise to complete these transfers before the changes are implemented.
• Seek Professional Guidance: Now more than ever, working with the right professionals—financial advisors, tax professionals, and attorneys—who can provide advice tailored to your specific situation is crucial. These experts can offer strategic insights that align with both current laws and anticipated changes, ensuring that your estate planning efforts are both effective and compliant.