By Attorney Garrett T. Smith
A new administration usually means that tax code changes are coming. While it remains unclear exactly what tax changes President Biden’s administration will usher in, two possibilities are that it will propose lowering the estate tax exemption and eliminating the stepped-up basis on death. The first would affect only multi-millionaires, but the second could have an impact on more modest estates and their heirs.
In 2017, Republicans in Congress and President Trump doubled the federal estate tax exemption and indexed it for inflation. For the 2021 tax year, the exemption is $11.7 million for individuals and $23.4 million for couples. As long as your estate is valued at under the exemption amount, it will not pay any federal estate taxes, and the vast majority of estates do not owe any tax. President Biden has expressed an interest in lowering the estate tax exemption. It could be more than halved to $5 million or even reduced to the previous exemption of $3.5 million for individuals.
Another possible tax change is to how property is valued when it is passed on at death. “Cost basis” is the monetary value of an item for tax purposes. When determining whether a capital gains tax is owed on property, the basis is used to determine whether an asset has increased or decreased in value. For example, if you purchase a stock for $10,000, that is the cost basis. If you later sell it for $50,000, you will have to pay taxes on the $40,000 increase in value.
Under current law, when a property owner dies, the cost basis of the property is “stepped up.” This means the current value of the property becomes the basis. For example, suppose you inherit a house that was purchased years ago for $50,000 and it is now worth $250,000. You will receive a step up from the original cost basis from $50,000 to $250,000. If you sell the property right away, you will not owe any capital gains taxes.
According to a New York Times article available at the following link –www.nytimes.com/2021/01/15/your-money/estate-tax-biden.html – the current administration may propose to eliminate the basis step-up rule. In the past, it was difficult to determine the original cost basis of some property, but in the digital age, that information is more easily gathered. The change could result in tax increases for some people inheriting property that has risen significantly in value.
If you have concerns about these rules changing, a trust may be a good way to protect your estate. Many tax experts believe changes to the tax code are likely; however, they probably will not happen right away due to other pressing national concerns with the pandemic. Also, over the past 25 years, the exemption amounts have either increased or plateaued. Although decreasing the exemption would be unprecedented, it is not impossible.