Democratic presidential candidate Joe Biden has released information about his proposals for changes to the way estates are taxed, and those changes could mean significantly higher taxes on property passed on to beneficiaries.
Change 1: Cut the tax exemption in half
The first of these proposals would reset the estate tax exemption back from the current amount which is exempt from taxation of $11,580,000 per person to $5,490,000. It appears that the tax exemption would continue to be adjusted for inflation, so this exemption would continue to move upwards with inflation. The current exemption means only a small percentage need be concerned with payment of estate taxes, so 99.8% or more of Americans need not be concerned with them. Although a reduction in the estate tax exemption as contemplated by Biden would mean more Americans would need to consider estate taxes in their planning, a huge percentage of estates can comfortably fit below the exemption, and thus pass tax free to heirs.
Change 2: Eliminate the step up in basis rules
The far scarier Biden proposal is the elimination of the “step up in basis” rules. These rules will adversely affect all estates. First, lets look at what a step up in basis is. Here’s a simple example. Mr. Smith purchases a tract of land for $100,000. He holds the land for many years, and his son eventually inherits the land, which is now worth $500,000. His son has his tax basis in the land stepped up to the date of death value, so that if he sells it, he’ll only have to pay taxes on any sales proceeds above the basis of $500,000, rather than his father’s tax basis of $100,000. This means that the $400,000 increase in value is never taxed. While this offends opponents of the rule, proponents would argue that the increase isn’t so much that the land has increased in value as much as it is just a reflection of years of inflation.
The real issue comes for those who inherit assets from parents or others who lack any records of what those assets were purchased for. Let’s face it, the step up in basis rules are as much a rule of practicality as a rule of tax policy. How are heirs to know what their bequesters paid for the investments which they are passing on? And the IRS takes the position that if you can’t document your tax basis, then you have a basis of zero. So for those who don’t inherit the necessary records to document the basis of inherited assets, the entire inheritance would arguably be subject to taxation. And it is far more likely that the wealthy will have maintained those records that the average Joe, so this rule may well have a disproportionate impact on those with smaller inheritances.
Then there is the question of when the tax must be paid. Will the gain be “realized” when it is inherited, or only upon the eventual sale of the asset by the heir?
Heirs already took a big hit to their inheritances with the passage of the SECURE act, which will require them to take out any inherited retirement accounts over a ten year period rather than their lifetimes, unless the heir is a spouse or they can qualify for one of the few other exceptions to the act.
This means that it is now ever more important to keep connected with professionals who can guide you through these issues and their impact upon wealth transfers to your heirs.
Michael G. Carroll