Congress alongside first year President Biden are planning major tax overhauls that would create several issues for beneficiaries. Raising taxes on wealthy Americans has become a focal point of the majority party in Congress and for President Biden, as Democrats plan to increase taxes to address certain inequalities in the economy. At the top of the list is an elimination of the step-up in basis estate tax provision, which is considered by some economists and lawmakers to be a tax loophole that allows individuals to avoid paying taxes on inherited assets. Economists have cited that this provision has allowed billions of dollars each year, that would have otherwise been taxable, to be swept under the rug, exempt from capital gains tax.
Under the previous administration, President Trump and Republicans in Congress passed the Tax Cuts and Jobs Act (TCJA, 2017), which increased the tax exemption on inherited assets to $11 million and is set to sunset in 2026 unless repealed by the Biden administration. President Biden has repeatedly stated that he would like to see estate tax exemptions reduced to their 2017 levels of $5 million or reduced further to $3.5 million. By reducing the tax exemption cap, more individuals would be subject to pay taxes on estates and gifts by the Internal Revenue Service (IRS), effectively bringing in more revenue for the Federal government to help pay for other initiatives.
On top of reducing the tax exemption, Biden and Congressional Democrats have proposed the idea of eliminating the step-up in basis provision, which has commonly been used to pass on certain assets to a beneficiary, while avoiding massive capital gains tax burdens. If the basis were to be eliminated, inherited assets like property, equities, collectibles, and gifts would be subject to massive capital gains taxes if they are sold by the beneficiary. For example, a property purchased for $250,000 is passed on to a beneficiary who inherits the property with a current market value of $525,000. The stepped-up basis dictates that if the beneficiary sold the property, their capital gains would be taxed starting at the fair market value of $525,000 instead of the original purchase price — significantly reducing the capital gain tax burden for the beneficiary compared to a carry-over basis, which is applied when a beneficiary has an asset transferred to them before the death of the owner.
If the beneficiary sold the house at the same price that it was inherited, they would not owe any capital gains taxes because the value of the sale would be equal to the inherited price. Therefore, the $275,000 increase in property value prior to being inherited would not be taxable to the beneficiary. Under the current law, if the beneficiary sold the property for $550,000, the stepped-up basis would calculate capital gains on a profit of $25,000 (since the property was inherited at a price of $525,000.) By eliminating the stepped-up basis estate tax law, the beneficiary would have to pay capital gains on any inherited asset that is sold using the original purchase price. As a result, a property that was purchased for $250,000, inherited at $525,000, and then sold by the beneficiary for $550,000 would have to pay capital gains taxes on what would be considered a $300,000 profit (current selling price minus original purchase price).
When it comes to capital gains taxes, the majority of taxpayers would likely fall into the 15% capital gains tax bracket based on earned income with single and married filers falling in the 20% capital gains tax bracket if they earn more than $450,000 and $502,000 each year respectively. President Biden has also promoted the idea of raising capital gains taxes, specifically targeting filers who earn more than $1 million in income each year by placing a 39% capital gains tax on those individuals. Capital gains are also considered income, so an individual who makes $100,000 a year would have the profit of their capital gains for the year added to their income, which could send them into a higher income tax bracket and, in turn, a higher capital gains tax bracket. An income of $100,000 a year would have a capital gain of $25,000 taxed at a rate of 15%, resulting in capital gains tax of $3,750 and a net profit of $21,250 after selling the inherited asset.
| Purchase Price | Fair Market Value | Selling Price | Capital Gains (Step-up) | Capital Gain Tax Rate | Taxes Paid on Capital Gains | Net Capital Gain |
| $250,000 | $525,000 | $550,000 | $25,000 | 15% | $3,750 | $21,250 |
Single beneficiary inherits an asset using a stepped-up basis with $100,000 annual income.
Should President Biden eliminate the stepped-up basis, that same individual making $100,000 a year would now be taxed at a rate of 15% on a profit of $300,000.
| Purchase Price | Fair Market Value | Selling Price | Capital Gains (No Step-up) | Capital Gain Tax Rate | Taxes Paid on Capital Gains | Net Gain |
| $250,000 | $525,000 | $550,000 | $300,000 | 15% | $45,000 | $255,000 |
Single beneficiary inherits an asset without a stepped-up basis with $100,000 annual income.
If the taxpayer were married and jointly earned more than $225,000 for the year, the $300,000 profit added to their income would push the married couple into the 20% capital gains tax bracket resulting in a tax bill of $60,000. Should the Congress and President Biden increase the top capital gains rate from 20% to 39.6%, as they have proposed, the tax bill for this married couple would be a staggering $118,800 and nearly cut their net gain in half.
| Purchase Price | Fair Market Value | Selling Price | Capital Gains (No Step-up) | Capital Gain Tax Rate | Taxes Paid on Capital Gains | Net Gain |
| $250,000 | $525,000 | $550,000 | $300,000 | 20% | $60,000 | $240,000 |
Married beneficiary (filed jointly) inherits an asset without a stepped-up basis with joint annual income of $225,000.
The step-up in basis provision saves more than $56,000 in taxes for married couples (filing jointly) who inherit assets in this scenario and more than $41,250 for single tax filers. Economists and lawmakers who have audited situations like this have concluded that billions of dollars of taxable income are voided because of the step-up in basis provision and have gone as far as alleging that the provision is a loophole rather than a tax strategy. Eliminating the provision however would cause an immense tax burden for all taxpayers, not just wealthy taxpayers as some lawmakers have purported.
In the previous Democratic administration, President Obama and then Vice President Biden attempted to eliminate the step-up in basis provision but were unsuccessful in large part due to a Republican controlled House and Senate. With a fully controlled legislature and executive branch, this initiative may have a better chance of making its way through Congress along with several other tax hikes and a partial or full repeal of the TCJA. These tax increases and changes are aimed to help finance other programs related to education and student loans, but they will impact how seniors plan to handle their assets and estates as they get older. Although the aim is to prevent mega-wealthy Americans from avoiding taxes, the elimination and reduction of certain provisions and exemption caps will have undue effects on the middle class — especially if step-up in basis is eliminated.
With the filibuster rule still intact, Senators need more than a simple majority to pass major legislation, such as those dealing with overhauling taxes, making the elimination of the stepped-up basis unlikely — unless the rules are changed. If Democrats in the Senate move to change or dissolve the filibuster, a simple majority vote would pass most if not all of President Biden’s tax agenda, which could cause major tax burdens for seniors and their beneficiaries when passing on legacy assets. A change of this nature can potentially open other loopholes for retirees and those planning for retirement to take advantage of moving assets into other tax favorable accounts like a trust. Should these tax changes be made, many seniors across the country may benefit from updating their plans to pass along assets to their beneficiaries.
