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Navigating the ‘Perfect Storm’ of Tax Changes in Washington and California

The start of a new year is as good a time as any to make a wish list. Many of us will take the opportunity to map out what we hope to accomplish in the coming year. Some of these goals will be achievable; others will be the stuff of hopes and dreams, with little prospect of materializing in the absence of a miracle.

So it is with political campaigns. Presidential candidates typically hit the campaign trail with a daring and ambitious agenda that they know will be diluted before it can be implemented. The jostling and compromises inherent in the Washington political process will see to that. The wish list that constitutes the Biden tax plan is extensive: increased maximum tax rates for capital gains; lower exemptions from estate and gift tax; elimination of the step up in basis on inherited assets.

Before the Georgia run-off, it could be assumed that implementation of the Biden tax plan would have required significant compromise in order for legislation to pass through a Republican-controlled Senate. The result in Georgia has dramatically changed that equation. With the Democrats set to control all three branches of government, it is conceivable that much of the Biden tax plan advanced during the campaign trail will become law.

This will have a significant impact in California. Under current law, an individual can leave around $11.5 million to her heirs without the estate having to pay tax on the inheritance. Under the Biden proposals, this exemption threshold would be lowered to $3.5 million, bringing many more families into the estate tax net, with estate tax potentially payable at a rate of 45%.

The incoming administration has also proposed eliminating the so called “step up in basis.” If you inherit a property or stocks from your parents, the current law essentially allows you to avoid paying capital gains tax if you sell the asset shortly after inheriting it. The proposed law requires you to pay the tax. So if you inherit a house worth $1.5 million that your parents paid $300,000 for, you will pay capital gains tax on the difference.

Compounding these tax changes that will take place at the federal level, Californians also have to contend with the impact of Proposition 19. This passed by the slimmest of margins on election day, and in doing so has swept away one of the enormous privileges hitherto bestowed upon homeowners by the tax system.

Under the current law, a parent can leave property to a child without the property taxes being reassessed. If someone bought a home 30 years ago for $200,000 and the property is now worth $1.5 million, that person is currently paying low property taxes based on the original value of the home. The child inheriting the home is able to continue paying those low property taxes.

Prop. 19 has effectively abolished this favorable treatment that has been enjoyed by children inheriting homes for decades, though subject to some limited exceptions. Unless the property is transferred to the child before Feb. 16, property taxes will be reassessed when the child inherits the property.

Tax reform typically proceeds at a snail’s pace. However, the Democrats are acutely aware that they may only be in control of the Senate for the next two years. They will be eager to effect these changes within that timeframe, but with COVID-19 and political unrest casting a long shadow, it is impossible to predict with any certainty what will occupy the legislative agenda as the new administration takes office.

What is certain, though, is that planning is critical. If you are planning to avoid the property tax increases due to Proposition 19, then Feb. 16 is a hard deadline that is fast approaching.

Should you give away your property before then to your children or to an irrevocable trust? That would avoid the property tax reassessment, but it could cause adverse capital gains tax consequences. For those families whose assets may be subject to federal estate tax, initiating a gifting program or creating certain types of irrevocable trusts may mean that your loved ones can hold on to a greater share of your assets after you pass.

There is no one size fits all approach. What is undeniable is that the blue wave has created a perfect storm when it comes to taxes. Don’t be caught without an umbrella.

Daniel R. Weiner is a trusts and estates attorney and holds a masters degree from Duke Law School.  He lives in the Del Mar area of San Diego with his wife, Miriam, and two young children, Aiden & Emma.

About Daniel Weiner

Daniel Weiner is a US and UK licensed attorney, based in San Diego, who provides trust administration and estate planning services to families and individuals across California. Dan guides his clients through the often confusing maze of financial and legal decisions to create plans that ensure the well-being of their families and the accomplishment of cherished family goals.


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