Biden’s Proposed Changes to “Step Up in Basis” Rules Could Have Big Impact
When it comes to issues of tax planning for a future estate, the estate tax understandably comes to mind first. The capital gains tax, however, is arguably a more important tax issue to keep in mind for many people when putting in place an estate plan. This is because of the significant benefit provided under the tax law commonly known as the “step up in basis.” However, on April 28, 2021, President Biden released his American Families Plan that would, in conjunction with proposed increases to the capital gain rates, result in a significant increased capital gain tax burden on inherited and highly appreciated assets.
Specifically, the proposal would effectively cap the “step up in basis” benefit to $1,000,000 of the gain for a single person or $2,000,000 for a married couple.
The issue is best explained with an example. Assume a farmer purchased 200 acres of farmland in 1990 for $400,000. The purchase price is known as the “cost basis.” Today those 200 acres are worth $2,400,000. If the farmer sold the farmland, he would pay capital gains tax on the $2,000,000 gain. If, however, the farmer holds an ownership interest in the farmland at the time of his death, then under the current tax law, the original cost basis receives a “step up,” and a new cost basis is established based on the date of death value of the farmland, which in this example is $2,400,000. If the farmland is sold by the farmer’s estate or the farmer’s beneficiaries for $2,400,000, there would be no capital gain realized and thus no tax owed.
Comparatively, applying the Biden proposal to this example, only $1,000,000 of the $2,000,000 gain would receive the step-up, and the remaining $1,000,000 would be taxable. Compounding the potential tax consequence of the proposed change is the Biden proposal to increase the capital gain tax rate, which, for the highest earners, would jump to 43.4%. Applied to this example, the result of these tax changes would be a tax liability of $434,000 for some individuals where, under the current tax law, there would be none. Even for those individuals who are not high earners, the tax consequences would likely be several hundred thousand dollars.
Although many estate planners have their eye on likely changes that are to come to the estate tax rules in the coming years, the proposed change to the “step up in basis” rule is likely to affect a greater number of people, and not just the super wealthy. If you have any questions regarding your estate plan, please contact one of our estate planning attorneys at FGKS Law.
