Possible Tax Law Changes after the Election – Part 2

Last week I wrote about the questions we have been receiving from clients about tax law changes coming after next month’s election and what to do now.  As I stated last week and I’ll say again, it is impossible to know now what changes may come, therefore, we can’t recommend any specific response.  But, I can talk about what has been said and what that might mean for many Americans.

Donald Trump has not provided any specifics on what he might do in a second term.  Joe Biden has, so let’s look at that.  Biden said he would undo some of the tax breaks given to corporations and wealthy individuals.  He has also stated that he would cut in half the estate tax exemption which is currently $11.58 million per person.  This is the amount that can be passed during one’s lifetime or at death in any combination that would be free of federal estate tax.  Halving it would bring the exemption down to $5.79 million (the exemption is indexed for inflation so this number is based on the 2020 exemption).

How would this affect most Americans?  Not much because a very small percentage of estates even approach $5 million.  The current exemption is higher than it’s every been.  Cutting it in half would still allow all but a few Americans to avoid paying estate tax.  This is especially true in the case of married couples who, with proper estate planning can exempt $11.58 million from estate tax ($5.79 million for each spouse).

The second possible change, however, could have an impact on more Americans.  Eliminating the step up in basis would cause many people to pay capital gains tax on assets they inherit.  This tax is not based on the size of the estate but simply on the unrealized gain on the particular asset.  Theoretically, it could affect anyone who inherits an asset.  

For example, we see many estates in which the only asset is a home purchased 30+ years ago for less than $100,000 that is now worth $500,000 or more.  When the children inherit it now after Mom or Dad has died, they only owe capital gains on the difference between what they sell it for and what is worth at the date of death.  If sold shortly after death there is no gain.  Eliminating the step up in basis could result in a gain of $400,000 or more and a tax of $60,000 or more depending on the tax bracket.

I would caution, however, that we need to see the details of what any new law would look like.  Right now it’s all just campaign talk right now in broad terms – the devil is in the details and we do need to know the details to be able know how this might affect you or I.  Let me explain.

Eliminating the step up in basis can be done any number of ways.  For example, the law could permit up to a certain threshold of capital gains to be exempted from tax so that the change would only affect more wealthy Americans.  This would be consistent with Biden’s stated intent to eliminate the income tax cuts passed in 2017 except for Americans earning less than $400,000.  

The law could target certain assets and not others. For example, the step up could be permitted for real estate or just residential real estate and not for stocks, bonds and mutual funds.  As is typical with our process of lawmaking, what is first introduced as a bill often looks very different after negotiations to obtain the support needed to gain passage into law by Congress and the President.  For these reasons it is premature to suggest any course of action in response to what for the moment is purely guesswork.  I also would not be overly concerned about it until we see the outcome of next month’s election.  That’s when things may begin to take shape – or not.