As a part of his Build Back Better agenda, President Biden has proposed The American Families Plan. In this plan, changes have been proposed to the current stepped-up basis provision, which would affect some key estate planning laws that have been in place for the last five years.
If your estate totals over $1 million, this proposal may impact your plans if it’s approved. Here’s what you need to know.
What is the stepped-up basis?
As described by the Tax Foundation, the stepped-up basis, or “step-up in basis” provision adjusts the value of an inherited asset, such as an investment, bond, or real estate, that was passed down after death. The value of the asset is reset at the time of the inheritance, without incurring capital gains. An asset’s original purchase price or value is referred to as the “basis.” Capital gains and losses are the difference between an asset’s basis and its value at the time of sale.
Currently, when an heir inherits an asset after death, they do not pay taxes on the asset’s basis, even if its tax basis had increased due to capital improvements. It’s not until a person sells an asset for a profit that capital gains taxes are due, as they only apply to the appreciation of an asset after the date when it has been inherited. However, this is not the case if a recipient is gifted the asset during the gift-giver’s lifetime.
With step-up in basis, it’s easy to sell assets after death with little to no income tax incurred by the recipient. The cost basis receives a “step-up” to its fair market value, reducing the capital gains the recipient of the asset will owe if they were to sell. In doing so, the capital gain that occurred between the original purchase and the heir’s acquisition is eliminated and never paid by any party.
How the Biden administration is proposing to change the stepped-up basis
In an effort to make the tax code more progressive and less advantageous towards the wealthy, President Biden is proposing a couple of changes to the longstanding step-up in basis rule.
Firstly, President Biden has proposed a raise in the top capital gains rate to 39.6%, from the current rate of 20%. As for the step-up in basis provision, there are some changes that would affect taxpayers with $1 million or more in annual income. After death, that amount can be passed on to a surviving spouse, increasing the survivor’s exemption to $2 million. When it comes to estate planning, the changes to the stepped-up basis would increase compliance burdens from taxpayers and increase the tax burden on capital.
Under the American Families Plan, if a beneficiary were to inherit a $500,000 stock which was purchased by the original owner for $100,000, it would maintain the $500,000 basis as long as the estate’s unrealized capital gains do not exceed $1 million, or up to $2 million if the original owner was predeceased by a spouse and received their exemption amount.
However, that could change for those whose assets have unrealized gains above the exemption amount. In this instance, a beneficiary would instead inherit the asset at the original owner’s basis of $100,000, rather than the basis getting “stepped-up.” If the heir were to sell the asset, they would then be responsible for paying all of the capital gains taxes on the original basis.
How will Biden’s proposal impact my estate?
At this stage, the change is just a proposal. However, changing the stepped-up basis rule would have the top income groups pay more relative to current tax values, rather than the value at the time of the original purchase.
If you’re wondering how the proposed changes to the step-up in basis rule could impact you and your Virginia estate plans, The Law Office of Patricia E. Tichenor can help answer your questions. Schedule a free consultation to discuss your circumstances and learn how these changes could affect your estate.