Deemed Sales Proposal and the Elimination of the Step-up Basis
Kevin Wong, Principal, Citrin Cooperman Advisors LLC / Berdon Advisors LLC
06.14.21 | T&E Chat
Step-up basis has been a mainstay in estate planning for more than 100 years. Upon a decedent’s death, assets in his or her estate are generally eligible for an automatic step-up in basis at the time of death or an alternate valuation date. This avoids a double tax on the assets via 1) income tax on the appreciation, and 2) estate tax based on the fair market value. However, this automatic step-up in basis may be coming to an end.
Tax law changes are inevitable with any new presidential administration as tax reform is a key topic of any presidential candidate. When former President Trump took office, he enacted the Tax Cuts and Jobs Act. This will be no different with President Biden and his administration. Biden currently has several tax reform proposals in the works. Under the American Families Plan, there is a proposal for a deemed sale of assets upon the death of the decedent.
During World War I, Congress enacted the Revenue Act of 1916, which gave rise to the modern federal estate tax that we see today. This taxed the transfer of a decedent’s wealth against the estate rather than an inheritance tax which was levied on the beneficiaries. The Revenue Act of 1921 provided that the basis of property acquired by gift in the hands of the donee would be the same as it was in the hands of the donor, referred to as the “carryover basis.” The Act also stated that the basis of property acquired from a decedent would be the fair market value as of the date of death, referred to as the “step-up basis.”
There have been many proposals throughout the years to repeal the step-up basis. These proposals have all fallen short. The only time in modern history when the step-up basis upon the death of the decedent was not guaranteed was during 2010. The estate tax was temporarily repealed by Congress for 2010. Congress realized it would be too generous to combine the repeal of the estate tax with a tax-free step-up in basis, so Congress coupled the repeal with a carryover basis for assets received from the decedent. Estates were given the option of an estate tax with an exemption of $5 million at a flat 35% tax rate, thereby preserving the step-up basis or no estate tax with carryover basis.
What does this mean for you?
This deemed sales proposal can lead to a significant increase in taxes by the decedent’s estate. Let us assume, for example, that a decedent had an estate valued at $15 million and had never used their lifetime exemption, which is currently $11.7 million in 2021. The assets were held long-term with a basis of $5 million. With the current estate tax rate of 40%, the estate would have to pay taxes of $1.32 million on the $3.3 million in excess of the exemption. The basis in the hands of the estate or beneficiaries would be the $15 million less any assets sold to pay the tax.
However, using the same example under President Biden’s tax proposal would lead to higher taxes. In addition to the $1.32 million in estate taxes, the estate would also have to pay income taxes of $2.38 million, which consists of the 20% long-term capital gains tax rate plus the 3.8% net investment income tax rate. The total tax to be paid by the estate would be $3.7 million. The basis of the assets in the hands of the estate or beneficiaries would still be the $15 million less any assets sold to pay the taxes.
The deemed sales proposal would lead to taxes on many estates that currently may not be subject to taxes if covered under the lifetime gift and estate tax exemption. Assets may need to be sold in order to raise the liquidity needed to pay the taxes. However, the American Families Plan does provide exemptions for gains under $1 million, as well as exemptions for family-owned businesses and farms given to heirs who continue to run the business.
This proposal, along with other tax increase proposals by the Biden administration, should be on taxpayers’ radars. Please speak with your tax and estate advisors to discuss how this may affect you and your family.
Questions? I can be reached at 212.331.7441 | firstname.lastname@example.org or contact your Berdon advisor.
Kevin Wong is a Tax Manager in the Personal Wealth Services Group of Berdon with nearly 10 years of professional experience. He works closely with high net worth individuals on matters involving their personal income tax, family businesses, and fiduciary, gift and estate taxes.