Don’t Delay—Proposed Changes to Estate Tax Law Aim to Eliminate Step-Up in Basis

If you’ve been waiting for the “right time” to start planning your estate, don’t wait any longer—the right time may be in the rearview before you know it. With a new administration in the White House, tax reform is on the agenda in Washington, and the proposed changes would have a major effect on many estates, especially for high-net-worth individuals.

Three separate tax reform proposals aim to eliminate the “step-up in basis” policy that currently shapes estate planning and taxing. In the law as it stands, an inherited asset’s tax basis will “step up” upon transfer from decedent to heir, meaning that the basis used to calculate capital gains tax is equal to the fair market value on the day of the decedent’s death. That way, if the inheritor decides to sell the asset, he or she won’t owe capital gains tax on potentially decades’ worth of appreciated value.

President Biden’s tax proposal, outlined in the “Green Book”, as well as the proposed 99.5 Percent Act and the STEP Act, would eliminate the step-up in basis for transferred assets in excess of $1 million in value. This means that the basis for capital gains will be the initial acquisition or investment cost—consequentially, inheritors of those assets will owe taxes on the difference between the often substantially appreciated market value and the initial basis.

What’s more, the Green Book proposes that transfer of assets upon death be a realization event. Under this proposed change, the estate will owe capital gains tax on those assets at the time of transfer, as though they had been sold. This income tax on the estate would come in addition to pre-existing estate taxes, generation skipping transfer (GST) taxes, and, in some cases, state capital gains taxes. Essentially, under the proposed legislation, the tax basis for estates will go from “stepping up” to simply carrying over from the decedent to the heir(s), resulting in significantly costlier tax burdens.

An additional complication that would result from the elimination of the step up is the issue of documentation. If the original basis of an asset is to carry over, that original basis must be, first of all, known and, second of all, demonstrated via the appropriate documentation. For assets acquired or investments made years or even decades in the past, tracking down the necessary records could be a complicated and arduous process—made all the more difficult for surviving relatives whose best hope of locating the records laid in the decedent’s own memory. If the basis of an asset cannot be demonstrated, the basis will default to zero, resulting in a gains tax on the total appreciated value of the asset (less the $1 million exclusion)—an even costlier tax price tag.

Fortunately, not all hope is lost. Even if signed into law, Biden’s tax plan would not affect gifts or estate transfers until after December 31, 2021 (though the STEP Act proposes a retroactive effect reaching back to January 1, 2021). In the meantime, it’s imperative to act quickly and deliberately to secure your legacy and avoid you or your loved ones having to pay substantially more in taxes. Consider utilizing estate planning and wealth transfer strategies such as a spousal lifetime access trusts (SLATs) and grantor retained annuity trusts (GRATs), or think about making charitable donations, which would be exempt from such taxes. Remember also to keep careful records for determining the tax basis for your assets—and don’t forget that reinvestments and improvement spending can help to raise that basis, if documented as well. Keep those records in mind when discussing estate plans so those who need to know have an idea of the basis of your assets.

If you need assistance navigating the increasingly complex world of estate planning and tax law, don’t let time and money get away from you—contact your McBrayer attorney today.

Ivan Schell is a Member of McBrayer PLLC. His multifaceted legal practice includes estate planning and administration, private foundation and public charity formation and planning, physician practice consultation and healthcare law, employee benefits law, and closely-held corporation planning transitions. He can be reached at ischell@mcbrayerfirm.com or by calling (502) 327-5400, ext. 2351.

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This article does not constitute legal advice.