Biden “could require heirs to take on the decedent’s basis when they receive an asset, known as carryover basis, but still allow heirs to defer realization of that inherited asset’s capital gain,” Eastman said. “This would raise much less than making death a taxable event—and even then, proposals to tax capital gains at death can have many exemptions.”
It is also important to note how the two proposals interact. “Since Biden is raising the tax rate on capital gains, the value of the tax expenditure for step-up in basis will mechanically increase. This is because the rate at which these gains would otherwise be taxed at would be higher,” Eastman said.
In addition, eliminating step-up in basis at death reduces a taxpayers’ incentive to defer realizing gains. Part of the reason why there is such a strong incentive to defer the tax on capital gains is that if an individual defers long enough, the tax on the asset will eventually be forgiven, Eastman said.
Without step-up in basis, a taxpayer has a greater incentive to realize the gain during their lifetime. As such, eliminating step-up in basis can indirectly boost revenue from capital gains.
While the plan will raise additional federal revenue in a progressive manner, it isn’t costless. Raising taxes on capital gains would reduce the incentive to save by reducing the after-tax return to saving.
“Lower domestic saving leads to lower income for Americans in the future and can lead to lower output by reducing domestic investment,” Eastman said. “In addition, there are administrative, structural and transition issues that Biden needs to consider if he ultimately eliminates step-up in basis,”
While it is premature to make predictions about what Biden and his Democratic-majority Congress will do, Biden has stated plainly that he wants to raise tax revenues by $3.3 trillion over the next decade.
“On a conventional basis, the Biden tax plan by 2030 would lead to about 7.7% less after-tax income for the top 1% of taxpayers and about a 1.9% decline in after-tax income for all taxpayers on average,” according to Tax Foundation analysis.
In addition to the potential new tax rates for those earning $1 million or more, Biden’s plan also seeks to impose a 12.4% Social Security payroll tax on income earned above $400,000, evenly split between employers and employees. This would create a “donut hole” in the current Social Security payroll tax, where wages between $137,700, the current wage cap, and $400,000 are not taxed.