Biden Tax Plan Begins to Take Shape – Part 2

In my post last week, I reviewed what we know so far about President Biden’s proposed tax law changes.  One change would increase the tax rate on capital gains, which currently is taxed at a  lower rate than  regular income.

Another change relates to the provision that wipes out the capital gains tax for assets that are passed at death.  This provision is what is known as the “step up in basis”.  It has saved many Americans who have inherited assets, hundreds of thousands of dollars or more.  Here’s how it works.

Normally, if I buy a stock for $1 and sell it for $10, I must pay tax on the $9 of gain.  If I hold the stock, however, till I die and my children inherit it, the basis becomes what it was worth when I died.  This allows my heirs to avoid tax on the gains during my lifetime.  In my example, I would only owe tax on any gain above $10.

President Biden plans to restrict but not entirely eliminate the step up in basis.  The first $1,000,000 of capital gains would be eligible for the step up in basis, thus exempting the tax on gain up to that limit.  A married couple would be able to each exclude $1,000,000.  Additionally, if the asset being inherited is the primary residence, the $250,000 exclusion for gain on a primary residence would also be available.  Again, in the case of a married couple, they each would be entitled to the exclusion which would total $500,000.

If a child inherited a home that he or she intended to live in and not sell, in most cases there would be no capital gains tax owed at death.  For other appreciated assets such as stock, there could be a tax owed and so some stock might need to be sold to generate the cash to pay the tax.

Biden’s plan attempts to address other potential inequities.  Capital gains on family businesses and farms would be entitled to the step up in basis, provided that the heirs who inherit it continue to run the business or farm.  This would avoid difficulties for businesses to generate the cash to pay the capital gains tax, which could be significant.

Obviously, the current proposal is short on details and many questions come to mind.  For example, would capital gains tax paid on these assets be entitled to a deduction against any estate tax owed?   We’ll just have to wait and see how things develop before we can talk about how estate planning may change and what opportunities may be created.  Stay tuned.