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Congress has once again tried and failed to nix a little-known tax break.
When House Ways & Means Committee chairman Richard Neal’s (D-MA) recent tax plan didn’t include a proposal to tax unrealized capital gains upon the death of their owner, it dramatically lowered the chances that such a move would occur.
Currently, any asset left to an heir has its basis, or the price upon which all increases in value are calculated for tax purposes, stepped up to its present value at the time someone inherits it. This can help heirs avoid large amounts of taxes on assets that have seen large value increases.
Neal’s omission stands in stark contrast to the hubbub from a few months ago when President Joe Biden was firmly behind such a tax hike, and it looked like Americans who planned to pass down appreciated assets to their heirs would have to reassess their estate planning.
But those best laid plans ran into the hard reality of politics. While Senate Democrats may try to resuscitate the increase in some form in the fall, the development should serve as a reminder to investors: Proposed legislation has a long way to go before becoming law.
“You need to step back and remind yourself that a proposal is not a guarantee,” said Andrew King, vice president of tax policy and research of Goldman Sachs Ayco Personal Financial Management. In other words, there’s no need to panic and shift your finances each time a new proposal hits Capitol Hill.
Why Did Biden Want to Change Stepped-up Basis?
Tax policymakers have long wrestled with the question of what to do with unrealized capital gains when the owners of those increases die.
If you were to buy a bunch of stock in ABC Corp. for $1,000 and then sell it in a few years for $10,000, you’d pay taxes on the $9,000 in gains over the initial price, or basis, that you made.
But what happens when you die? Right now, your holdings in ABC Corp. would pass down to your heir and would be subject to estate taxes (though only a few have estates large enough to actually owe any tax). The basis, though, rises (or falls) to the fair market value of the asset.
So when you die, your heir would receive the $10,000 in appreciated ABC Corp stock, with a basis of $10,000, rather than $1,000. That means when they go to sell it, they’d be subject to a lot less in capital gains taxes.
This has been a white whale for many progressive politicians and policy wonks for years. Back in the 1970s, Congress even passed a solution, though it was never implemented and ultimately repealed.
The plan that Biden and many Democrats settled on was to tax unrealized capital gains at death. To lessen the burden on non-wealthy households, Democrats planned on including a $1 million personal exemption for individuals (up to $2.5 million for couples), plus $250,000 for a home.
Biden’s plan had a few benefits: First, it would bring in a lot of money, and Democrats needed to come up with ways to pay for their roughly $3.5 trillion social programs bill.
But it would also work hand in hand with a proposed rise in the capital gains tax rate. After all, you can raise the capital gains rate as high as you want, but the Treasury will only get the money when someone decides to sell. And with stepped-up basis in effect, that could be a long time for some assets as they could conceivably be passed down for generations tax free.
While he avoided changing stepped-up basis rules, Neal did propose raising the top capital gains rate to 25%. This percentage doesn’t include the 3.8% net investment income tax, meaning wealthy households may soon face an almost-29% tax on investment gains.
“That will encourage some investors to hold on to assets until they die so they can pass them on untaxed to their heirs,” noted Tax Policy Center senior fellow Howard Gleckman in a blog post.
Why Did Biden’s Stepped-up Basis Proposal Fail?
When you create a picture of this proposal in your head, you probably imagine a spiffily dressed octogenarian in a tony brownstone not being allowed to use a tax break that will enrich his Wall Street scion. And that’s certainly the case in many instances.
But the proposals also fall on people who elicit a bit more sympathy from the general public, such as farmers.
Former stalwart Democrat Montana Senator Max Baucus laid out such an argument in an Wall Street Journal editorial in early September.
“Eliminating the step-up would force family businesses and ranchers to liquidate when an owner dies and to lay off employees while bringing in little revenue for Uncle Sam,” wrote Baucus.
His argument illustrates that the reaches of this bill go far beyond stocks.
Land-rich, cash-poor family farms, for instance, would potentially owe taxes on millions of dollars of appreciated inherited land. While Biden tried to lessen the burden on family-owned-and-run businesses (they wouldn’t owe taxes until the inheritors sold them and then they’d have 15 years to pay), rural state Democrats were not swayed.
“[W]hile the clear intention of making changes to stepped-up basis is to ensure vast fortunes worth tens or even hundreds of billions are not passed on without any income taxes paid at any point, we are concerned about the unintended burden this could place on farms and family business,” wrote Rep. Cindy Axne (D-IA) and others in a letter to House Speaker Nancy Pelosi and Richard Neal.
Democrat Senator Jon Tester, who currently represents Montana, also never supported the move. Democrats cannot lose a single Senate vote, without picking up corresponding Republican support, if they want to pass the bill, making his support critical.
These politicians, who are otherwise supportive of President Biden’s agenda, did not trust that their communities would be spared from the worst effects of the bill.
The Future for Stepped-up Basis Proposals and You
To be fair, reforming stepped-up basis rules are not completely dead.
Senator Elizabeth Warren (D-MA) called nixing the rule “low-hanging fruit” while Senator Mark Warner (D-VA) voiced support for replacing it with a carryover basis. Under that scenario, the original basis of a particular asset would transfer from the deceased to the heir, which means there wouldn’t be taxes owed on unrealized gains at the time of death. The heir would then be taxed whenever they sold the asset, allowing family-owned-and-run businesses, for instance, to continue to function unimpeded by crushing tax burdens.
Warner’s place makes intuitive sense, but it runs into a few problems. Some owners of assets may not actually have the records of what they paid for their assets, or any improvements they may have made over time to raise the basis, which is one of the reasons stepped-up basis exists. Moreover, carry-over basis wouldn’t bring in revenue as quickly as taxing unrealized gains at death would.
The debating this matter is moot, anyway, unless Tester and other rural Democratic Congressmen get on board.
All of that is a long way of saying that complicated policy proposals have a long way to go before becoming law, even when supported by the party in complete control of Congress and the White House.
While it can make sense to call your financial planner or attorney when big news breaks in Washington that may affect your wealth, think long and hard before making any sudden moves.
And even if Congress succeeded in raising your taxes (or the taxes others would face upon your death), that doesn’t mean a future Congress won’t undo it.