Updated: May 3, 2021
The American Families Plan is a proposal by President Biden to significantly increase federal spending in areas related to childcare, paid leave, pre-kindergarten, community college and healthcare.
It may also dramatically change how you transfer old assets to your heirs.
The American Families Plan – What You Need to Know About Estate Planning
What it May Do:
Raise capital gains taxes and end a rule that has been the cornerstone of estate planning for generations of wealthy Americans. The Biden proposal would blow up the following longstanding tax concepts:
That capital gains deserve a lower tax rate than wages.
People can inherit old assets without paying capital gains taxes.
Congress created the lower tax rate as an incentive to invest and prevent the tax code from discouraging asset sales. It is also a rough adjustment for inflation and a way to limit taxes on income already taxed at the corporate level.
Raise the top capital gains tax to 43.4% from 23.8% and taxing assets as if sold when someone dies.
It would claw back some benefits congress gave to slightly less wealthy millionaires who have been spared from the estate taxes but would face capital gains taxes at death.
Unrealized capital gains would not be taxed upon the owner’s death, minus a $1M per-person exemption.
Loss of some of the new owner’s stepped-up basis.
Today, people who own assets that have boomed in value – Apple stock, the family beach house, a three-generation manufacturing company – you don’t pay capital-gains taxes unless you sell. Under the Biden proposal, those unrealized gains would trigger taxes upon the owner’s death, minus $1 million per-person exemption.
More than two-thirds of all U.S. households have unrealized capital gains, according to the Federal Reserve. Some senators are balking at the impact on family-owned farms and manufacturers, who tend to be asset rich and cash poor.
Heirs historically have had to pay unrealized gains when they sell the asset and only pay tax the amount of gain (appreciation) since the prior owner’s death. This provision is known as the stepped-up basis and has been a part of the tax code since the Revenue Act of 1921. Tax attorneys warn that the loss of the stepped-up basis would turn estate planning upside down.
Example Under the Current System:
Someone purchases a business for $2 million, and it appreciates to $12 million; the owner then passes away. No capital gains would be due, and if this were their only asset, no estate tax would be due.
Example under the Biden proposal:
The owner who passed away would owe tax on $9 million ($10 million minus the $1 million exemption). The top marginal tax rate would be 43.4%. Assets held in retirement accounts generally aren’t affected.
Working in Tandem
The capital gains rate change along with taxation at death produces the outcomes Congresses is seeking. Without the change in basis, people would hold assets that they would otherwise sell. Asset owners would face a roughly tax-neutral choice – pay taxes now on a sale or at death later.
A Real Example
Vera Dunn lives in Beverly Hills, California, with her 102-year old mother in a house that was purchased for $100,000 in 1965. It is worth $10 million today. Vera borrowed $4 million against the home to care for her mother’s care. She is worried that she won’t be able to pay the taxes and keep the house. “Nobody’s going to cry over my situation, but I think many people can take my example and relate it to their own situation – a family business that has appreciated, or a long-held family home.
Solutions to Consider:
Gifting to loved ones before the owner passes away.
Accelerate asset sales if the proposed changes take effect and monitor the effective date. The assets could be a family business or appreciated stock if you planned the sales in the next few years regardless of the tax-law changes.
Donating appreciated assets to charity.
Wait out the policy.