How The American Families Plan May Affect The Stepped-Up Basis

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You are likely familiar with Benjamin Franklin's famous quote, “In this world nothing can be said to be certain, except death and taxes.”

Tax codes can be highly complex. However, your hard-earned tax dollars help fund several public services and programs, such as Social Security, transportation, etc.

Year after year, legislators propose several different tax codes and, in the American Families Plan, President Biden has included a proposal for a few changes to the way capital assets are taxed when an individual passes away.

Though these alterations are touted as being geared toward taxing the wealthiest of individuals, it eliminates the stepped-up basis, which can affect earners at all income levels.

This is because the burden of payment may end up resting on the beneficiary’s shoulders, who may earn an average American salary, rather than the wealthy individual who passed on their investments and inheritance.

According to Whitehouse.gov’s American Families Plan Fact Sheet,

“The President would eliminate the loophole that allows the wealthiest Americans to entirely escape tax on their wealth by passing it down to heirs. Today, our tax laws allow these accumulated gains to be passed down across generations untaxed, exacerbating inequality.

The President’s plan will close this loophole, ending the practice of “stepping-up” the basis for gains in excess of $1 million ($2.5 million per couple when combined with existing real estate exemptions) and making sure the gains are taxed if the property is not donated to charity.

The reform will be designed with protections so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the business. Without these changes, billions in capital income would continue to escape taxation entirely.”

Passing a general increase on the capital gains tax can cause taxable revenue to decrease, as investors would wait to sell their stocks and take their capital gains.

That is why eliminating the stepped-up basis in this bill is an essential component, since death is inevitable, and the U.S. Treasury can then step in and tax the capital gains of those who passed and their beneficiaries.

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Why Does Stepped-Up Basis Matter When Estate Planning?

Estate planning helps ensure that your loved ones appropriately receive their assets upon death, protecting those assets from creditors, and the state from deciding who receives what. Estate planning helps eliminate the opportunity for assets to get caught up in the court system.

However, with the proposed elimination of the stepped-up basis in the American Families Plan, if you pass down any stocks, real estate, or other capital assets to an heir, your beneficiaries may have to prepare to pay a capital gains tax on it.

Stepped-up is a provision in Section 1014 of the Internal Revenue Code, stating:

“In general. --Except as otherwise provided in this section, the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent shall, if not sold, exchanged, or otherwise disposed of before the decedent's death by such person, be (1) the fair market value of the property at the date of the decedent's death…”

Essentially, if the beneficiary sells the capital asset immediately upon receiving it, they would not be subject to paying a capital gains tax on that transaction. However, if they waited and it gained X amount in value, then sold it, they would be subject to paying a capital gains tax on the increased value from the time they inherited it to the time they sold it.

By removing the stepped-up basis, upon inheritance, the beneficiary would have to pay the capital gains tax earned from their predecessor.

For example, imagine you earn $50,000 annually. Your grandfather passed away and left you his vacation home. He originally bought that home for $300,000, but now it is valued at $1.8 million.

Under current law, you would inherit the property as $1.8 million and either keep or sell it without having to pay a capital gains tax.

If this provision in the American Families Plan passes, the estate would owe a capital gains tax on $500,000 upon your grandfather's death. If his estate couldn’t pay that tax, then the burden would fall on the beneficiary who may end up having to sell that home.

Here are a few key takeaways on how this plan would affect estates:

  • Ending the stepped-up basis for gains of $1million or more
  • Raising the capital gains rate to 39.6%
  • Donated properties to charities, family-owned businesses, and farms (if heirs continue running it) will be exempt from a capital gains tax
  • Continuation of the existing capital gain exclusion of up to $250,000 ($500,000 for joint filers) upon transfer of a primary residence

Preparing Your Estate & Beneficiaries

Tax code are always subject to change. Though there may be revisions to Biden’s proposed American Families Plan, including the removal of his proposed tax changes, there are ways you can prepare your estate and beneficiaries regardless of the legislative outcome.

For example, you could invest in municipal bonds or an individual retirement account (IRA). Or perhaps you donate an appreciated asset to a qualified charity.

An estate planning attorney can help advise you on how to best prepare your assets for when you pass. If you need help determining your best course of action and would like to discuss how you can avoid probate, creditors, loss of assets, and have a smooth transition of assets to your beneficiaries, Contact the Law Office of Audra Simovitch today.

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