President Biden has proposed fundamental changes to our estate tax policy that could dramatically increase the taxes paid by your heirs. His proposal, has left many estate planning lawyers in shock. If implemented, the changes would substantially raise taxes on the wealthy as well as the middle class. The President’s plan proposes two changes that would significantly increase your heirs’ taxes.
Elimination of Your Heirs’ Step-Up in Basis
First, the President’s plan would eliminate what is called a step-up in basis at death on capital gains taxation given to heirs of an estate. To better understand the significance of this proposal, you must first understand your capital gain tax. The IRS defines a capital gain or loss as the difference between your basis (purchase price) and the amount you get when you sell an asset (sale price). For example, if you purchased $1,000 in stock and sold that same stock today for $100,000, you would have to pay tax on your gain of $99,000.
Using that same example, say instead you bought the stock for $1,000 but passed away before it was sold. Currently, your heirs would receive a step-up in basis. Meaning, they are given a new cost basis for the assets valued at the date of your death. If the stock was worth $100,000 at the date of your death and your heirs sell the stock a couple years after your death for $110,000, then their taxable gain would only be $10,000. This is because your heirs’ basis is stepped-up to the value of the stock at the time of your death. In this scenario, their new stepped-up basis would be $100,000. As such, your heirs are only taxed on gains realized from the time of your death to the date the stock is sold. The step-up in basis applies to inheritances received from a probate estate, trust, or other estate planning vehicle.
The President’s proposal would eliminate this step-up in basis. Under his proposal, your heirs would instead receive your cost basis of $1,000. Therefore, in our example, if your heirs sold the stock for $110,000 after your death, they would pay capital gains tax on $109,000. Under the current capital gains rate (15% for most people), your heirs would pay $16,350 as a result of President Biden’s proposal. Under existing law, without the proposed changes, they would pay $1,500.
Increase to Capital Gains Tax Rates
Adding insult to injury, the second part of the President’s plan seeks to raise the top capital gains rate from 20% to 39.6%. As a result, some heirs could pay as high as $43,164 in taxes on the example above. That is an increase, for top earners, of $41,364 in taxes. Although stocks were used to illustrate the proposal, the new tax would presumably apply to all assets, including real property, tangible property and business assets. The administration’s plan is very similar to that of former President Obama. However, President Obama’s plan, while also extreme, only attempted to raise the top capital gains rate to 28%, not 36.9%.
If implemented, the President’s plan could be particularly devastating to family businesses who would be required to pay the tax on a deceased family member’s share of the business. Farmers would also be hit particularly hard as the President’s proposal would cause huge tax liabilities for family-owned farms and ranches.
What Can You Do?
Time will tell if either of these proposals garner enough support to become law. If passed, however, this would be a dramatic tax increase born by all Americans, not just the wealthy. Further, it could disrupt years of estate tax planning done by financial advisors, tax professionals, and estate planning attorneys, in reliance on current tax policy.
Learn More About Estate Tax
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About the Author: Aaron R. Shahan is an attorney at Atlas Law, PLC. Aaron dedicates his practice to virtually all aspects of estate planning, elder law, and probate.
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