June 24

Understanding Biden’s Stepped up Basis Reform

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When President Joe Biden was still in the middle of campaigning for his Presidency, he made a promise to his people that he wouldn’t raise taxes on middle-class Americans. However, it appears that there’s a provision in his major social programs bill that could do what he promised he wouldn’t.

A few months ago, President Biden revealed the American Families Plan—a proposal that could essentially transform how capital gains taxes are being paid on properties when the property holder passes away. Even though it may only seem like a small change within the tax rule, otherwise known as stepped up basis, this change has the potential to make average Americans pay more to the United States. Asides from that, estate planning for the rich will be completely turned upside down.

If you’re one of the citizens who will be affected by this proposal if it happens to become law, this article will suggest a couple of steps you can take to be prepared.

What Is Stepped Up Basis?

Before anything else, though, let’s refresh our minds as to what the stepped up basis is all about. Whenever anyone inherits assets, it is thanks to stepped up basis a.k.a step up in basis that those people receive major benefits. Most of the time, these inherited assets will have already increased in value since the time the original (now deceased) person bought them, especially if the assets were purchased decades ago. When assets get sold by the inheritor, they usually get taxed for it. However, thanks to the stepped up basis, the tax bill is significantly minimized.

The key concept here is “basis.” For example, imagine that you bought stock worth $200,000 and after a few years, you were able to sell it for $350,000. To know how much you need to pay in capital gains taxes, you need to remember how much you initially paid for that stock—otherwise known as the basis. So in this case, your basis is $200,000 while your taxable capital gain is $150,000.

As far as we can remember, the basis of an asset that’s inherited is “stepped up” to that asset’s fair market value during the time of the original owner’s passing. So, let’s put up another example: let’s say that you inherited stock and held onto it, passing it down to your children or heirs. After several decades, your $200,000 stock is now worth $600,000. If you pass away and your child inherits that stock, the basis would be raised to $600,000 from the original $200,000 since the current fair market value is being considered. If there are any future taxes to take into account, those will be calculated according to this new value. As a result, your heirs could save a significant amount of capital gains taxes.

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Biden’s Proposal

Now, let’s talk about President Biden’s proposal. The important components of his tax reform include increasing the capital gains rate to 39.6% while eliminating stepped up basis completely. According to an analysis made by the University of Pennsylvania’s Wharton School, the increase in capital gains could possibly cause revenue to decrease as a result. This is because they expect investors to completely change their actions and delay the selling of stocks instead. This is why the increase of capital gains goes hand-in-hand with the elimination of stepped up basis, as the latter could significantly increase revenue in case it does decline due to the former.

What Happens if the Stepped up Basis Is Eliminated?

While having an increase in revenue is a good thing, getting rid of stepped up basis could cause the middle-class to pay more in taxes. For instance, Monica is an unmarried teacher who only earns about $60,000 annually. This makes her an average American, and since Biden promised that those earning less than $400,000 won’t experience a tax raise, Monica won’t be affected when the administration passes tax increases.

Now, let’s say that Monica’s father died suddenly, and he left a wonderful vacation house to her name. When he bought it back then, it was worth $300,000, but now, its value has increased up to $1.8 million. Based on the current law, Monica would inherit the vacation house and its basis would be $1.8 million. At this point, she has the option to either keep the house for herself or sell it immediately so that she doesn’t have to pay anything in terms of capital gains taxes.

On the other hand, if we consider Biden’s plan, the estate that Monica inherited would owe $500,000 in capital gains. If Monica isn’t able to pay the bill, which could go as much as $100,000, she’ll have no choice but to sell the property. If you think about it this way, the average American Monica is, in fact, impacted by the administration’s proposal.

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What Should Be Your Next Course of Action?

Admittedly, the above scenario wouldn’t be a typical thing to happen, since most Americans don’t have incredibly rich fathers with vacation homes worth millions of dollars. Still, the idea of raising taxes especially during a time when the economy is still recuperating from the impact of COVID-19 will cause tempers to flare.

In any case, if you think that you’ll be affected by this proposal or you’re in the process of planning out your estate, there are some things you can do to prepare yourself.

Get Advice From Tax Lawyers

When Biden was still campaigning, tax lawyers and tax directors such as Joseph Velkos received a myriad of calls from clients asking what would happen if or when Biden won the election. At that point, Velkos advised them all that they should start planning out their next courses of action for whatever changes will take place in Congress. Stay connected with your tax advisers, as they can inform you what’s changing and what you should do next.

Collect Any Documentation

While some people don’t think that the bill will pass, it’s better to be safe than sorry. As such, locate and collect as many documents as you can related to your assets or estates, and give them to your accountant so they can keep them safe for you.

Conclusion

We hope that you gained better insight and understanding regarding President Biden’s stepped up basis reform. Without a doubt, many people will protest this change, so be ready for whatever happens next.


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