President Biden’s proposal to eliminate the step-up for calculating inheritance taxes targets a tactic that has long been a wealth-preservation tool. What are some of the ramifications of the proposal and what, after political wrangling, could be the tax implications for large inherited assets?
Biden proposes taxing the appreciation of property on gift or at death as capital gains or ordinary income. “That’s what he’s proposing. How he’s going to do that is another issue,” said Tim Tikalsky, principal at Sensiba San Filippo in Pleasanton, Calif. “The threshold is going to be, for transfers of property, over a million dollars. If an estate is under a million, I believe he’s going to allow a step-up basis.”
The Biden White House designed the tax hikes to pay for the president’s two new spending bills—the American Jobs Act and the American Families Act. Combined with Biden’s March Covid-19 relief bill, the total tab for all three packages is $6.4 trillion over 10 years, or $50,000 per American household, according to the Congressional Budget Office. The proposal is reportedly meeting resistance from both Republicans and Democrats in Congress.
A step-up in basis recalculates the value of an appreciated asset for tax purposes upon inheritance, when the asset’s value typically exceeds its value when purchased (likely years before). For the beneficiary, the step-up in basis at the death of the original owner reduces the capital gains tax on the asset.
Currently, taxpayers pay estate tax on the value of their assets and the basis of appreciated assets is stepped up to fair market value. “President Biden’s plan would treat appreciated assets held at death as sold, thereby triggering income tax, as well as subject these same assets to estate tax,” said Karen L. Goldberg, principal-in-charge of the trusts and estates group of EisnerAmper in New York.
Biden’s proposal could also end up subjecting many to a “death tax” they would not otherwise face, Goldberg said, given the current $11.7 million estate tax exclusion ($23.4 million per married couple). “This could easily happen, for instance, if a widowed mom dies with a $3 million estate that largely consists of the home that she and her husband lived in for the past 40 years,” Goldberg said. “Although her estate would owe no federal estate, it could easily owe income tax on the deemed sale of this highly appreciated home.”
The proposal allows a $1 million per person ($2 million per married couple) exclusion from gain recognition on property transferred by gift or held at death. The recently released Green Book of the administration’s proposed tax policies clarifies that the $1 million per person exclusion is in addition to exclusions for property transfers of tangible personal property, transfers to a spouse, transfers to charity, capital gain on certain small business stock and the current exclusion of $250,000 per person for capital gain on a personal residence.
How can wealthy clients prepare when federal tax policy often starts with scary proposals and ends somewhere in a negotiated middle?
“We do encourage clients to transfer properties now if it makes sense economically,” Tikalsky said, adding that the estate-planning exemption is scheduled to go down in five years to $5 million from the current $11.7 million.
Goldberg recommends clients continue with their estate planning based on current law. The “likelihood of this proposal passing in its current form is questionable,” she said “It may be virtually impossible in many cases to track an asset’s basis ... and enforcement of this rule by the IRS would be administratively burdensome.”
“Clients should continue planning with the historically high $11.7 million gift/estate tax exclusion before it’s reduced,” she added, “which could happen even before 2026 under the current administration.”