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Retirement

How Estate Tax Changes Could Affect You And Your Family

By Chris Farrell, Next Avenue

You’ve probably been hearing about how the Biden administration wants to raise the 21% corporate tax rate and the 37% top income tax rate and 20% capital gains rate for the wealthiest Americans. But changes in the estate tax rules, under consideration by the president and Congress, haven’t received as much attention. They could, however, affect you and your family.

There are two proposals to alter the way taxes are imposed on estates at death you’ll want to know about.

Biden said during the campaign that he wanted to tax unrealized capital gains at death, regardless of whether the heirs sell the asset at that time.

The first is the federal estate tax exemption.

Since 2018, estates are only taxed once they exceed $11.7 million for individuals; $23.4 million for married couples, at a top rate of 40%. (The value of a primary home is exempted up to $250,000 for individuals and $500,000 for married couples.) The estate tax gets levied on property, including cash, real estate, stocks and other assets transferred at death to heirs.

Lowering the Estate Tax Exemption

The Biden campaign proposed reducing the estate tax exemption to $3.5 million per person ($7 million for a married couple), which is what it was in 2009, while increasing the top rate to 45%.

With the current $11.7 million threshold, very few Americans ever have to deal with the estate tax. The Urban-Brookings Tax Policy Center estimates that only about 4,000 individuals dying in 2018 left estates large enough to require filing an estate tax return. After allowing for deductions and credits, a mere 1,900 estates owed the tax. Considering the sophisticated tax avoidance techniques available to the really rich, the estate tax has essentially become a tax on plutocrats.

The second possible change is about the treatment of capital gains at death.

Changing the “Stepped Up” Basis Rules at Death

A capital gain occurs when an asset is sold for a higher price than its purchase price, known as its “basis.” When you inherit an asset, under current law, the “basis” is its value at the time of the owner’s death. That’s called — pardon the tax jargon — the “stepped-up basis.”

So, today, when someone dies, capital gains are only taxed once the heir sells the asset at a profit based on the value of the asset when he or she received it (not what the original owner paid).

Here’s a simplified illustration. Your mother bought stock for $10 a share in 1990 and the stock was worth $200 a share at her death in 2018. You inherit the stock without paying any capital gain and sell the stock this month at $400 a share. You’ll only owe capital gains taxes on the difference between $200 and $400.

Now, here’s how things could change: Biden said during the campaign that he wanted to tax unrealized capital gains at death, regardless of whether the heirs sell the asset at that time. Put another way, if this proposal takes effect, the “stepped-up basis” rules would end and heirs would owe taxes based on the difference between what the deceased originally paid and the value at his or her death.

No Sure Thing

To be sure, neither of these proposals are guaranteed to become law. In fact, Republicans on Capitol Hill aren’t keen to hike estate taxes. That’s not just because they’re united against higher taxes. It’s also because many have tried to eliminate estate taxes over the years.

“The politics of the estate tax is hard, especially given the nature of the Senate,” says Howard Gleckman, senior fellow in the Urban-Brookings Tax Policy Center at the Urban Institute. Adds William Gale, senior fellow in the Economic Studies Program at the Brookings Institution: “People who don’t like the estate tax don’t like it if you turn it into an inheritance tax. They just don’t want to pay the tax.”

That said, the Democrats control both houses of Congress and the White House and Washington is looking for ways to raise revenue due to the ballooning budget deficit.

Taxes tied to death have a long history, dating at least to 7 century B.C. in Egypt.

“Honestly, people have been trying to tax death or tax events around death about as long as they’ve been taxing anything.”

“Honestly, people have been trying to tax death or tax events around death about as long as they’ve been taxing anything,” said tax historian Joseph Thorndike in a podcast interview with David Stewart, editor in chief of Tax Notes Today International.

The History of Estate Taxes

In the U.S., he added, in the early years of the death tax, it was ” a war tax.” From 1797 to 1802, it helped pay for the Quasi-War with France. A stamp duty was put on inventories of deceased persons, receipts of legacies, shares of personal estate and probates of wills to help pay for America’s naval forces.

The U.S. government imposed an inheritance tax during the Civil War and then repealed it in 1870. And the first federal estate tax came about in 1898 to pay for the Spanish-American War; it was abolished in 1902.

The modern estate tax became permanent in 1916. In many respects, it’s similar to today’s. 

Democratic Estate-Tax Reform Bills in Congress

The outlines of the current estate tax debate are becoming (somewhat) clear.

Take a recent proposal by Democratic Senators Kirsten Gillibrand (N.Y.), Sheldon Whitehouse (R.I.), Chris Van Hollen (Md.), Jack Reed (R.I.) and Bernie Sanders (Vt.). They’re behind the “For the 99.5% Act.” (Democratic Representative Jimmy Gomez (Calif.) has introduced a similar bill in the House).

Said Van Hollen in a statement: “The stepped-up basis loophole is one of the biggest tax breaks on the books, providing an unfair advantage to the wealthiest heirs every year.”

This legislation would lower the estate tax exemption to $3.5 million for individuals and $7 million for married couples at a 45% rate and gradually increase the rate to 65% for estates worth $1 billion or more.

A separate proposal sponsored by progressive Democratic Senators Van Hollen, Cory Booker (N.J.), Sanders, Elizabeth Warren (Mass.) and Whitehouse — along with a similar bill from Rep. Bill Pascrell (D-N.J.) would exempt the first $1 million from capital gains tax at death (indexed to inflation). Any value greater than that would be considered a capital gain. Farmers and small businesses could pay the tax in installments over 15 years; Pascrell’s bill has a seven-year installment plan. (This bill wouldn’t change the exclusion for primary homes up to the current limit.)

The politics of designing the stepped-up basis this way is to defuse political and voter opposition by ensuring that middle class people don’t pay the tax at death.

Opposition to Estate Taxes

For most of the estate tax’s history, it has been controversial, largely because the tax involves critical value judgments about society and the economy.

Many wealthy families oppose the tax. They’ve successfully harnessed opposition to it over the decades, with studies showing that the estate tax discourages entrepreneurship, family businesses, wealth accumulation and savings.

Polling data shows that even people who would likely never owe the tax often recoil at the notion of the Internal Revenue Service imposing a “death tax” (or, even more colorfully, the “grave robbers’ tax” and “grim reaper’s reward.”)

A cottage industry of professional advisers has grown to help the rich avoid the tax, too. (If you’d like to see how complicated estate tax planning is, check out the slides about proposed changes from a recent presentation by attorney Alan Gassman.)

Proponents of estate tax changes, however, believe the economic criticisms never really hold up to close scrutiny. More importantly, they say, the tax itself is designed — however flawed — to lean against accumulated economic privilege and inequality.

Simplifying the estate tax could put an end to many loopholes and complicated tax-avoidance strategies. Still, in the end, the estate tax is really a national debate about ethics and morality.

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