Before he was elected, President Biden campaigned on a promise to lower the estate tax exemption limit, and to consider abolishing the step-up in basis for capital gains tax. While it is difficult to predict when the Biden administration will turn its attention to taxes, it appears that their current priorities are managing the pandemic and shoring up the economy. That leaves a small window to consider how these proposed changes may impact your estate plan, and to prepare any necessary changes in advance of when it will be discussed.
Gift and Estate Tax Reform Proposal
The Tax Cuts and Jobs Act passed in 2017 raised the Gift and Estate Tax exemption limit from $5.49 million per individual, or $10.98 million per married couple, to $11.7 million for individuals, or $23.4 million for married couples. This increase will expire in 2025, if no other laws are passed. President Biden’s campaign platform, however, included a proposal to decrease of this exemption to $3.5 million per individual, or $7 million for married couples (the level it was when President Obama took office). This means that individual estates between $3.5 million and $11.7 million (or $7 million to $23.4 million for married couples) will be subject to estate taxes, should his proposal become law. He also proposed an increased tax to those estates in the top bracket from 40% to 45%.
Eliminating the Step-Up in Cost Basis for Capital Gains
President Biden’s campaign platform also included eliminating the step-up in cost basis for capital gains tax. Presently, when a beneficiary inherits property, the tax basis for that property is “stepped-up” to the fair market value at the time of the decedent’s death.
For example, Jane bought a house in 1952 for $80,000. If she sold the house in 2006 for $780,000, she would owe capital gains taxes on $700,000 ($780,000 - $80,000 = $700,00).
Instead, assume that Jane passed away in 2006 and left the home to her son, Mark. Mark sold the home two years later (just after the housing market crashed) for $500,000. With a step-up in basis, Mark doesn’t owe any capital gains tax, because the home lost value from when he first acquired it ($500,000 - $780,000 = -$280,000). However, without a step-up in basis, Mark would owe capital gains taxes on the amount over the price his mother originally paid ($500,000 - $80,000 = $420,000).
If this becomes law, it may be possible to use more sophisticated planning tools, like trusts, to avoid significant capital gains taxes. This tax is likely to have a broader impact on moderate-wealth families, so it is important to talk to an estate planning attorney about implications of capital gains taxes on your familial wealth as part of your comprehensive estate plan.