May 25, 2021



Proposed Estate Tax Reform Seeks to Cut the Stepped-Up Basis, Raise Tax Rate

A provision in President Joe Biden’s relief plan could cause average Americans along with the uber wealthy to pay more to the federal government when they die, which means your kids or other heirs may get less than they would under the current estate tax laws.

President Biden’s COVID-19 relief package, the American Families Plan, includes a proposal to change the way capital gains are taxed when people pass away. According to economic policy experts, the revision to a tax rule called the stepped-up basis has the potential of being a big revenue raiser for the plan. This, coupled with Biden’s proposed reduction in the federal estate tax exemption to $3.5 million likely will result in tax hikes for not only for the uber wealthy and the well-off but also for everyone who has something of value to pass along to heirs.

The proposed changes are not yet law, and there will surely be lots of Congressional haggling over the measures. But they’re out there and looming. Right now, it’s important for you to keep abreast of what’s going on in Washington and keep in touch with your accountant, financial planner, and estate attorney to make sure you get a handle on how estate tax reform will specifically impact your estate situation.

Inheritance With and Without the Stepped-Up Basis

The stepped-up basis is defined in IRS Tax Code 1014 which says the basis of an inherited asset rises to “the fair market value of the property at the date of the decedent’s death.” Inherited assets like your house or equities in your stock portfolio typically have gained in value since you purchased them. These capital gains are taxable, but the stepped-up basis wipes out the capital gains tax when heirs inherit an asset, which significantly reduces the tax liability when and if the inheritor eventually sells the asset.

For example, if the house you bought for $200,000 years ago has grown to a fair market value of $700,000, the $500,000 in capital gains would not be taxed when your son or daughter inherits it. Plus, if years later, they sell it for $950,000, their personal capital gains would be valued against the $700,000 fair market value of the house at the time they inherited it. The same would be true for stock. There would be no tax when your heirs inherit it and upon sale, the gains would be based on the difference between the market value at the time of your death and the time they sell it.

With the proposed Biden changes, the step-up basis would be eliminated, and your heirs would be taxed on the carryover basis of $200,000 either at the time of your death or at a future date when they sell the asset—and the taxation may be at a new, higher 39.6 percent rate (which is another part of President Biden’s proposal). The use of the carryover basis would be applicable on all assets transferred in the estate.

Then There’s the Gift Tax

Currently, the unified federal estate and gift tax exemption is at an historically high $11.7 million and integrates both the gift and estate taxes into one tax system. You can give as much as $15,000 to as many people as you want during the year without being subject to a gift tax. If any gift exceeds $15,000, you are required to submit a form to the IRS but not required to pay a tax until, if and when, you exceed the $11.7 million exemption. On December 31, 2025, that exemption, which was increased under the 2017 Tax Cuts and Jobs Act (TCJA), will sunset to the pre-TCJA level of $ 5.3 million per person. President Biden, however, has proposed that the estate and gift tax exemptions be decoupled and return to 2009 levels: $3.5 million for the estate tax exemption and $1 million for the gift tax exemption with an increased maximum estate tax rate of 45 percent up from the current flat 40 percent rate.

What You Should and Can Do Now

If you’re planning your estate now, reviewing your current plan, or expect to be the beneficiary of an inheritance, we recommend you consider these strategies to better arm yourself for potential changes Congress may make to the estate tax code.

  1. Gather Up all Your Records – If you’re not certain where you’ve put all these records, now is the time to find them, store them in a safe place, and send copies to your accountant and your estate attorney. One reason the current stepped up basis rule exists is that it can be difficult to keep track of an asset’s cost basis. In the case of real estate, for example, records of the kitchen renovation or the addition you built several years ago would favorably impact the carryover basis, making it higher. Similarly, if you reinvested dividends and interest in your stock portfolio, that too, would increase the carryover basis.
  2. Consider Making Charitable Donations or Establish Trusts – You can still donate an appreciated asset to a qualified charitable organization and receive a deduction on the full market value. Trusts will allow you to pass assets to heirs with as little tax as possible.
  3. Purchase an Insurance Policy – If you’re leaving an asset or assets that you anticipate will cause your heirs to face a big tax bill, consider including a life insurance policy as part of your estate. This will help your heirs pay the tax.
  4. Gift Prudently – You must seriously think about how you make large lifetime gifts. Even now, we advise clients who want to reduce their estate or get assets out of their names to gift liquid assets. Gifting liquid assets with no capital gains implications makes more sense than an asset like your house or your stock.
  5. Stay in Touch – Start talking or continue your dialogue with your tax advisors (e.g., your accountant, financial advisor, and your estate attorney). With potential estate tax reform on the horizon, staying connected with these professionals is more important than ever. Change can be daunting but being informed will enable you to be ahead of the curve and, therefore, more flexible and at the ready to make specific adjustments quickly.

At Phelan, Frantz, Ohlig & Wegbreit, LLC, we are knowledgeable of estate tax laws and issues and stay continually abreast of the ongoing changes in estate tax law—and are always available to provide you with the guidance you need for your unique situation.

Call us at (908) 232-2244 to ensure that you’ll be fully prepared for whatever estate tax reform Congress may send your way.

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