With President Biden’s first address to a joint session of Congress this week, we learned a little bit more about his proposed tax changes. Keep in mind that these are only proposals at this time and are not law.
- Stepped Up Basis: Presently, when a person passes away, their heirs and/or beneficiaries receive a step up in basis on any capital assets that are transferred to them upon the owner’s passing. The new owner will take a basis of fair market value as of the owner’s date of death. So, if the asset had appreciated substantially during the owner’s life, all of that capital gain would not be taxed. President Biden is proposing to repeal the step-up in basis of inherited assets at death for gains in excess of $1million ($2.5 million per couple), with protections for family owned businesses and farms. At this time, it is not clear if death will trigger a realization event (meaning the tax would be due immediately), or if the heirs would be given a carryover basis. Keep in mind, this has been tried before in the US and was repealed due to the extreme difficulty in implementing rules.
- Ordinary Income: President Biden proposes to restore the top income tax rate of 39.6% for those with income greater than $400,000.
- Capital Gains: President Biden proposes to increase the capital gains tax rate from 20$ to 39.6% for households making more than $1million. Combined with the surcharge on investment income to pay for the Affordable Care Act, the capital gains rate for those making more that $1million would more than double to over 42%.
- Real Estate – 1031 Exchange: The proposal is to end the 1031 like-kind exchange rules, eliminating the ability to defer capital gains tax on real estate exchanges for gains above $500,000.
It is worth noting that the President’s proposals did not mention and changes to the federal gift and estate tax exemption, which currently stands at $11.7 million per individual ($23.4 million per married couple). It should be noted that if Congress does nothing to address it, the exemption will revert to $5 million per individual, adjusted for inflation, after 2025.
You should also note that these are the proposals put forth by the President. Senator Bernie Sanders has introduced the “For the 99.5% Act” that has much more impactful tax changes, especially with regard to stepped-up basis and the federal estate and gift tax exemptions. Under Senator Sanders’ bill, the estate tax exemption would drop to $3.5 million and the exemption for lifetime gifts would drop to $1million from the current $11.7 million.
It is worth noting that the Senate Parliamentarian ruled that the reconciliation process that was used to pass the COVID relief bill earlier this year, can be used more than once. That means that instead of making these changes after the end of the Federal Government’s fiscal year on September 31, they can make the changes much sooner if they choose. The good news is none of the proposals are calling for retroactive effect back to the first of the year, but if you are contemplating making lifetime gifts to your heirs in order to take advantage of the current large exemptions, you may want to act soon.
We at Stroup Meengs, PC will continue to monitor the proposals and update as things evolve.