By: Katie Sapp, Day Pitney
In the wake of the change of administration, many have continued to speculate about what tax reforms we can expect from the Biden administration and Democratic-controlled Congress. While the likelihood of imminent tax reform is still widely unknown, proposals from President Biden and his campaign during the 2020 presidential race suggest that they have part of their focus on eliminating the step-up in basis for property transferred at death.
Early in Biden’s campaign, he told fundraisers that he would like to “close loopholes like capital gains and stepped-up basis.” In a more recent proposal, Biden’s Plan for Education Beyond High School explicitly states that it would raise funds to support said plan in part by “eliminating the stepped-up basis loophole.” More generally, Biden’s campaign highlighted their commitment to capital gains reform with the goal of getting rid of capital gains tax loopholes for the wealthy. In addition to eliminating the step-up in basis, Biden has proposed increasing the income tax rate on capital gains above $1 million to the same rates as ordinary income.
Biden has not elaborated on what eliminating the stepped-up basis would look like. With such little information surrounding this proposal, commentators have had to look to other sources for more detail, such as the “Greenbook” revenue proposals of the Obama Administration. The final 2016 edition of the Greenbook includes a proposal to “Reform the Taxation of Capital Income.” This plan would treat the transfer of property at death or during life as a realization event, thereby imposing an income tax on the property’s appreciation.
The Greenbook includes the following additional details:
- The gain would be taxable income to the donor in the year the gift was made, and to the decedent either on the final individual return or on a separate capital gains return. The tax imposed on gains realized at death would be deductible on the decedent’s estate tax return, if any.
- Gifts or bequests to a spouse or charity would carry the donor’s basis. Capital gain would not be realized until the spouse’s later death or disposal of the asset. Any property donated to charity would be exempt from capital gains tax.
- No gain would be realized on tangible personal property, specifically excluding collectibles.
- The current $250,000 in the case of single taxpayers (and presumably the $500,000 in the case of married taxpayers filing jointly) exclusion of capital gain on a principal residence would be extended to apply to all residences. Every taxpayer would also be allowed an additional exclusion of capital gains up to $100,000 (indexed for inflation). Both exclusion amounts would be portable to a surviving spouse.
- To facilitate and implement the proposal, the Greenbook outlined additional legislative changes that would take effect, including: the allowance of a deduction for the full cost of appraisals of appreciated assets, the imposition of liens, the waiver of penalty for underpayment of estimated tax if the underpayment is attributable to unrealized gains at death, and broad authority granted to the Secretary to issue regulations as necessary, among other changes.
Noting that the Biden administration has not formally submitted its own proposal with respect to reforming taxation on capital income, the Greenbook proposal might accurately reflect the current administration’s vision. That said, assuming the Greenbook proposal were adopted in full, we could see a dramatic decrease in inheritances. For example, assume a taxpayer with more than $1 million in annual income bought $10,000 worth of X shares 20 years ago. Assume further that, today, those shares are worth $500,000 and that she leaves these shares to her only child. As of today, that child would receive the full $500,000 worth of shares (subject to estate tax) and the new basis for those shares would also be $500,000. The child could then sell those shares with an effective appreciation of $0 and have no capital gains tax liability.
Assuming the facts above and that Biden’s plan also includes the taxation of capital gains at the same rates as ordinary income, the new capital gain tax liability would be $194,040 at the top proposed rate of 39.6%. The child would now only receive $305,960 worth of shares (subject to estate taxes).
Eliminating the step-up in basis at death would have serious implications for wealthy individuals looking to pass significantly appreciated assets to their heirs. That said, it’s not entirely clear whether or not the step-up in basis will actually be eliminated. For one, the Biden administration has not provided any detail as to their own plans for implementing this proposal. In addition, this is not the first time an elimination of the stepped-up basis has been proposed. Even with a Democratic-controlled Congress, interest in this issue may wane in favor of other issues as it makes its way through the deal-making process. Still, this is a potential change in law estate planners should keep an eye on, particularly if and when the Biden administration begins to provide more details on this proposal.