By John A. Meier, II
Imbedded within all the news about Covid and other domestic issues can be found news about new tax proposals. However, much of that news is very confusing. If you search "Biden Tax Hikes" on the internet, your search will return over 31 million hits. With this much information, there is little chance that the average person can understand what is truly being proposed. However, there appears to be some proposals that are receiving a lot of attention. The most significant proposals that affect many of our clients are the increase of the maximum income tax rates, including the capital gains rate, and the elimination of the step-up in basis of inherited assets. Changing the rates is simple; just change the rate(s). Tax rates have been increased and decreased many times over the years and will change yet again. Congress certainly seems to know how to change tax rates! Making changes with long-standing cost basis concepts will be more difficult.
Cost basis is generally the purchase price of an asset. There are ways the cost basis of an asset can be adjusted depending on the type of asset. For example, the cost basis for stocks can be affected by stock splits, dividends, and return on capital distributions. For some assets, there can be a step-up in cost basis when someone dies owning the asset. Here's an example: Assume you purchased a parcel of real estate for $30,000 and held the real estate until your death, under the current regulations, the cost basis is not what you paid for the real estate ($30,000) but is often the value of the real estate on the date of your death. assume the parcel of real estate on the date of your death is now worth $50,000. If you sold the real estate before you died for $50,000, you would have a $20,000 taxable gain. If your estate sold the same real estate after your death for $50,000 there would be no gain because your estate received a step-up in the cost basis to the value of the real estate on your date of death ($50,000). One of the matters being considered in the new tax proposals is doing away with the step-up in basis for inherited assets. If this happens, your estate (or beneficiaries) will have to pay taxes on the gains they make when inherited assets are sold.
Another tax proposal being considered is making more of your estate subject to estate tax and doing so at higher tax rates. Basically, the estate tax is the amount your estate must pay based on the value of assets being transferred to others after your death. Presently, most estates do not have to pay estate transfer taxes because a large part of most estates are currently excluded (exempt) from taxes. If the amount of an estate that is excluded from the estate transfer tax is significantly lowered, it will not be surprising that significantly more estates will be subject to estate transfer taxes.
What many in Congress will not acknowledge (or do not seem to know) is that basis is not "free." Someone had to acquire the asset by paying up money (or giving some other kind of consideration or thing of value). It is profoundly unfair to double up the tax by first taxing the money that went to pay for an asset, doing away with the step-up in basis and lower the estate tax exemption amount thus taxing the asset again. Politicians can certainly do away with stepped-up basis. However, if they do away with the step-up in basis, subjecting those same assets to estate tax should be eliminated. Unfortunately, this seems unlikely.
What can you do? It certainly seems clear that the advantage of holding assets until death (for the step-up in basis) will be eliminated and higher capital gain tax rates will apply. If possible, consider making gifts to avoid having future appreciation of those assets in your estate. It may also be attractive to consider establishing and funding certain types of trusts.
John Meier has been assisting clients with their estate planning, long term care planning, elder law, trust administration, and probate needs since June of 1985. John heads up FCW's Estate Planning and Probate divisions and continues to focus his efforts assisting individuals and families with their estate planning, long term care, elder law, probate, and trust administration needs. John has been named to Georgia's Legal Elite and Atlanta Magazine's Top Wealth Managers, and currently serves as the City Attorney for Waleska, Georgia. He is also a Certified Trust and Financial Advisor, a nationally recognized certification, distinguishing him among his peers.