Estate Tax Planning in a Biden Presidency (part 4)
The Biden proposal to eliminate a step-up in basis is radical and dramatic. Being both radical and dramatic substantially decreases its chance of success in the legislative process, but what are the “step-up” basis rules? To read about other parts of his proposal, see our prior articles.
A taxpayer’s basis is usually their purchase price of an asset. When sold for a gain, the difference between the sales price and basis equals the capital gain subject to capital gain tax rates. Although the rates charged on capital gains are not this simple (we are talking the Tax Code here), for many that rate is 20% and we will use that for our discussion. Accordingly, taxpayers who hold assets for an extended duration, commonly individual stocks and real estate, see those assets substantially increase in value building up an untaxed capital gain. Selling those assets triggers the taxation of the capital gain, e.g. the gain is “realized.”
One long-time feature of our tax code is that the beneficiaries of an estate receive the asset with a “step-up” basis. The spouse, children, or other beneficiaries of a decedent’s estate do not pay a capital gain based on the price the decedent purchased the asset, but a value at the date of the decedent’s death. Because of inflation and other reasons, this is usually an increased value so the basis “steps up.” Unlike estate taxes, which apply to only those above the exemption amount, the capital gain tax applies to all taxpayers and the step-up basis rules benefit beneficiaries of even modest estates.
Here is a simple illustration: Ms. A purchases 100 shares of Apple for $100 a share (a $10,000 investment). She holds them for many years and now they are worth $1,000 a share. If she sold them, she would pay a capital gain of $900 a share. If she passes, her beneficiaries receive a basis of $1,000 a share (assuming that is the value on date of death), and if they immediately sell the stock, they pay no capital gains tax. The savings to the heirs is $18,000 ($90,000 gain taxed at the assumed 20% rate).
President Biden has proposed to eliminate the step-up in basis rules. This could cause a substantial tax increase to all taxpayers, regardless of whether their estate was subject to estate taxation. Children who inherited a modest rental property could find that they owe a substantial capital gain for that inheritance. Otherwise, under current law, they would pay absolutely no tax for receiving this property and promptly selling it at the date of death value. That is why eliminating the step-up in basis would be both a dramatic and radical change in the law. It could affect millions of taxpayers.
It would also create a substantial and difficult burden on beneficiaries’ estates to prove and determine the basis of the decedent. They would, in fact, be punished if the decedent kept poor records. If a taxpayer normally cannot prove their basis, the basis is assumed to be zero. The step-up in basis rules make it easy on beneficiaries to prove the basis by obtaining appraisals and valuations as of the date of death. If instead the decedent’s records are lost, destroyed, or unavailable, the beneficiaries might see the entire sales price taxed as a capital gain.
Step-up in basis has been an integral part of the estate and gift tax law since the inception. That is why changing the law would be hard to fathom. But this is Congress, so who knows? If you don’t like letting Congress determine what you do in life, are there good planning options?
If you have assets with significant unrealized capital gains, unless and until the law changes, I see no reason to change your investment and tax strategy. If holding the asset makes sense, continue to do so. If the law changes, and you’ve only been holding the asset hoping to pass it to your heirs without the burdens of capital gain, maybe then you decide to go ahead and sell and pay the capital gain tax.
In my opinion, it is best to simply keep up to date on Biden’s tax proposals, and if a tax act is signed by the President that actually eliminates the step-up in basis, then review your portfolio and decide if any assets have been held not because they have great investment potential, but for fear of capital gains taxes. In those cases only, and only in the event of the passage of the tax act, would I consider selling those assets.
There are many complexities to estate tax planning, and the step-up basis rules are as much a part of capital gains and general taxation as opposed to estate taxation, so other considerations may counsel to sell assets now and incur the capital gain. As always, consult your tax professional.
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, specific tax, legal or accounting advice. We can only give specific advice upon consulting directly with you and reviewing your exact situation.
