Like many of you, we have been closely watching congress and the White House to see what changes in law may be coming that could affect your estate. On Wednesday, the Biden Administration proposed a massive change.
In the American Families Plan, the White House proposed removing the “step-up” in basis on assets left to beneficiaries at our death. If this proposal is enacted, it would require many clients to do a full analysis of their estates and potentially make significant changes or additions to their estate tax strategies.
Here is how the old law works:
- Year 1 – Steve buys a share of MB Corp stock for $1 (Steve’s basis in the stock is $1).
- Year 10 – Steve passes away and the share of MB Corp stock is worth $100.
- Steve leave this share of stock to his daughter Julie through his living trust.
- Julie receives the stock at its $100 value (Julie’s basis is $100).
- The $100 value is included in Steve’s total estate to determine whether he owes Federal estate taxes at a 40% rate. If taxes are owed, the estate pays the taxes. Estates under $11.7M ($23.4M for a married couple) do not currently owe any Federal estate taxes.
- If Julie then sell the share for $100, she pays no capital gains tax because the stock basis stepped-up from $1 to $100 at Steve’s passing.
- Therefore in the current system, no taxes are owed on the appreciation (gains) in the stock value during Steve’s life and no estate taxes are owed if the estate is valued at less than $11.7M.
President Biden’s Proposed Change:
- Year 1 – Steve buys a share of MB Corp stock for $1 (Steve’s basis in the stock is $1).
- Year 10 – Steve passes away and the share of MB Corp stock is worth $100.
- NEW TAX: If Steve’s estate contains significant gains*, then Steve’s estate owes a tax on the appreciation from $1 to $100. Rather than receiving a step-up in basis, gains are deemed realized at Steve’s death and the taxes are owed EVEN THOUGH THE ASSET HAS NOT BEEN SOLD.
- Then NEW RATE: The proposal also raises the top capital gains rate to 39.6% for filers who report more than $1M of income. Meaning that Steve’s estate could owe $39.30 in taxes just on the gains of his MC Corp share (and there may also be a Medicare surplus tax of 3.8%).
- Steve leave the share of stock to his daughter Julie through his living trust.
- The $100 value is included in Steve’s total estate to determine whether he owes Federal estate taxes at a 40% rate (though it is not clear from the proposal whether a deduction would be available for the capital gains taxes owed). If taxes are owed, the estate pays the taxes at a current rate of 40% on assets in excess of $11.7M.
- While it would be relatively easy to sell a share of stock in order to pay these significant taxes. Requiring an estate to hold a fire sale of rental properties in order to pay the capital gains would be more difficult and costly. Therefore, close tracking of estate assets, basis, and gains is required.
*The proposal includes an exemption for the first $1M of gains and makes a reference to the primary residence inclusion that suggests an additional exemption of $250,000 might be available at death.
At this stage, the American Families Plan is a proposal from the White House. But, the proposed reforms to the capital gains are also contained in the Sensible Taxation and Equity Promotion (STEP) Act submitted by Senator Van Hollen last month.
Other relevant proposals:
- The 39.6% income tax bracket will be added back to the rate list.
- Capital gains rates will be increased to include a matching top bracket of 39.6% for high income filers.
- The Medicare surplus tax of 3.8% will be maintained and expanded to hit more families, so the top potential rate for Capital gains is 43.4%
- 1031 Exchanges may no longer be available for gains exceeding $500,000.
- The administration will put resources toward more and deeper audits of high-income families because it believes that a significant portion of income is not being properly reported.
- Separate from the American Families Plan, Senator Sanders has submitted the “For the 99.5% Act” to the Senate. This Act proposes reducing the estate exemption to $3.5M per person and lowering the lifetime gift exemption to $1M.
