Make No Mistake – This Would Be A Massive Tax Increase on Estates

Let’s dig a little deeper into how Mr. Biden’s tax proposal impacts estates.

Elimination of Step-up in Basis

Experts in the tax world are most wound-up about the capital gains tax.  For many years, individuals have been able to give inheritances of appreciating assets without imposition of any capital gains tax.  We’ve always called this a “step-up” in basis.  

Here’s how the step-up in basis works:

Let’s say you purchased $10,000 worth of Apple stock back in 2006.  Let’s say you die in 2021.  That same Apple stock has gone up in value significantly.  The difference in the lower price and the new higher price is called “capital gain,” and you have to pay capital gains tax on the difference in values if you sell the Apple stock during your lifetime.  However, if your kids inherit that same Apple stock at your death, they get a “stepped-up basis,” which means they would not have to pay any capital gains tax.

Let’s continue our example.  You purchased those shares in 2006 for $10,000 and then died in 2021 when those same shares are valued at approximately $500,000.  That’s a capital gain of $490,000.  Under current tax laws, when your kids inherit those shares they would pay $0 in taxes. 

Under Mr. Biden’s proposal, if the step-up in basis is eliminated, your kids could owe a whopping $194,040!  That’s 39.6% of the value of the long-term capital gain.  Yipes!

Increase the Capital Gains Tax Rate

Mr. Biden also proposes to raise the tax rate of the capital gains tax.  Under the proposal, the capital gains tax rate would mirror the rates of income taxation.  For example, instead of paying capital gains tax of 15%-20%, the new rate could be as high as 39.6%.

Reduce the Estate Tax Exemption

Reducing the Estate Tax exemption is another way of saying, “increasing the estate tax.”  Under current law, each deceased person’s estate can give away about $11.5 million without imposition of any estate taxation.  That means couples can give away about $23 million at death to their children, estate tax free.  Under the Biden proposal, this would get reduced to just $3.5 million per person. 

Raise the Estate Tax Rate

Mr. Biden’s tax proposal would also increase the rate at which inheritances are taxed.  The rate would be increased from 40% to 45%.  Keep in mind this would be in addition to that capital gains tax discussed above.

Consider this illustration:

Mom and dad have stocks in their retirement accounts worth $10 million at the time of the second-to-die’s death.  They give those accounts to their son through a last will and testament.  The stocks in those accounts have seen appreciate of $9 million (meaning, the original basis was just $1 million).

Under current law:  The son pays no taxes on the inherited stocks.  Nada.  Zilch.  $0.  The son gets all $10 million.

Under Mr. Biden’s Proposal:  There would be a 45% Estate Tax on the amount over $7 million.  There would also be a 39.6% tax on the capital gain.  That means the son would have to pay taxes of $4,914,000.  The son gets $5,086,000 of the parents’ original $10 million.