A couple of months ago, President Obama announced he wanted to end the so-called step up provision in the capital gains tax. Some dismissed it right away, saying the Republican Congress has vowed to not see it come full circle.
But what does it mean in terms of how these changes will shape the way inheritances are taxed?
Capital Gains Tax and Step Up Provision
President Obama announced his desire to eliminate the tax benefits associated with inheritances and tax capital gains based on the decedent versus the step up basis for how those assets are passed on. Many say this could actually make it harder to protect assets from taxes.
As estate planning lawyers, we know that if it is indeed passed, it’s going to require big changes in the “planning” part of estate planning. Among challenges are the trust fund loophole. The president proclaimed it was time the wealthiest Americans begin to pay their fair share.
Unfortunately, there are potential flaws in his efforts of leveling the playing field. In fact, it’s entirely possible that it would greatly affect beneficiaries and would require an entirely new way of determining the cost basis on inherited assets.
On the surface, that sounds little more than another frustrating rule, but once you delve a bit further, you begin to see just how convoluted this can become. Many families have various assets, whether it’s a family business or real estate and anything else of value would have to be traced back in order to determine the original cost.
A house bought in the late 40s costs $10,000. At the time of your death, the house appraises for $100,000. That means your gain is $90,000 and you’ve paid no taxes on it. If you leave the house to a child, his cost basis is $100,000. That $100,000 threshold is where the line is drawn: if he sells the house a year later, he will owe a capital gains tax on anything above $100,000 in value and nothing else. Now, if these new laws are passed, your son is only exempt for the original $10,000, meaning he’s also paying taxes on that $90,000.
If you’re married, this new plan could mean that married couples may bequeath investment assets with capital gains up to $200,000 tax-free. If it’s bequeathed to a child, $500,000 in capital gains are safe.
Not a Cure All
The reality is, unless these potential problems are addressed, it could become problematic for families in any income bracket. There are too many unanswered questions and instead of leveling the playing field he mentioned, it actually places a bigger burden on middle income families. It doesn’t make sense. It could, however, become a bit more feasible, but not without many problems being addressed before the changes. Otherwise, we’re going to be stuck with an estate planning rule that serves no purpose at all for the families behind the estate plans.
If you’re looking to make sense of your estate planning efforts, we invite you to contact our offices today.
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