Now that the Democratic party has taken control of the White House and both chambers of Congress, there may be new legislation passed that impacts the way inheritances are taxed. We will provide some insight in this post.
Elimination of Stepped-Up Basis
Let’s say that your rich uncle passes away, and he leaves you a thousand shares of stock. The stock is worth $100 a share, but he bought it years ago when it was valued at $10 a share.
Your uncle paid $10,000 for the stock, and it grew in value by $90,000 while it was in his possession. The question is this: do you have to pay the capital gains tax on the $90,000 gain?
Clearly, your uncle would have been required to pay the tax if he would have sold the stock while he was living. However, when you inherit the assets, they would get a stepped-up basis.
For capital gains purposes, the meter would be reset, and you would not be responsible for the gains that took place during your uncle’s life. If you keep the stock and you sell it later after it appreciates beyond the $100,000 in value, you would pay capital gains tax on those fresh gains.
During the Democratic presidential primary season, some of the candidates floated the idea of a so-called “wealth tax.” Joe Biden was not one of them, but he made a proposal that would in effect be an additional tax on the wealthy.
He stated that he would like to do away with the step-up in basis, and he would use the revenue to help fund free junior college tuition for American students. It remains to be seen if this will come to fruition, but it is an issue that you should be aware of if you intend to use this loophole.
Estate Tax Exclusion
The federal estate tax carries a 40 percent maximum rate, so it can take a significant bite out of your legacy. However, most people do not have to be concerned about this tax, because you can transfer a large amount tax-free before the remainder would be subject to taxation.
This amount is called the estate tax credit or exclusion. In 2011, a $5 million exclusion was established via legislative mandate, and it was retained through 2017 with adjustments to account for inflation. During that year, the exclusion was $5.49 million.
At the end of 2017, the Tax Cuts and Jobs Act was enacted, and it took effect in 2018. It raised the exclusion to $11.18 million, and this figure has remained in place since then with inflation adjustments. In 2021, the estate tax exclusion is $11.7 million.
While he was a candidate, Biden expressed his desire to return the estate tax exclusion to “traditional levels.” Since the exclusion was in the $5 million range for seven years recently, it is logical to assume that this is the level he was referring to when he stated the policy position.
As it stands right now, the provision in the Tax Cuts and Jobs Act that raised the exclusion is going to expire or sunset at the end of 2025. If no new legislation is enacted in the meantime, the exclusion will go back to the 2017 level of $5.49 million adjusted for inflation.
Of course, a tax law can be passed in the meantime that accelerates the timetable, and the Democratic majority makes this a distinct possibility. This is another situation that will unfold over the coming months and years, and we will pass along updates if and when they become available.
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