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Most people have probably never heard of a “stepped up basis,” but it might just be the most important tax loophole in America — one that billionaires use to pass vast sums of wealth down to their heirs by avoiding capital gains taxes.

This supremely obscure and yet wildly consequential rule concerns assets passed from one person to another when they die. If a parent buys a stock for $1 and leaves it to their child (or for that matter, anyone) in their will, the tax code changes — or “steps up” — its base value, from the original price to whatever it was worth when the person died. Say that stock was worth $100 when the person died. If the child sells it later for, say, $150, the child would owe taxes only on the $50 upside, instead of the entire $149 profit the family made off the stock over the course of two generations. In April, former Senator Heidi Heitkamp of North Dakota called it “one of the biggest scams in the history of forever.”

For a select few families with vast fortunes amassed over many generations, it means that they can pass down millions or billions of dollars in stock, investments or real estate without having to pay income or capital gains taxes on many decades, or possibly a century or more, of gains. The windfall grows each time the money is transferred, endowing those families with disproportionate power for generations to come.

https://www.nytimes.com/2021/09/24/opinion/biden-tax-loophol...
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Completely overlooked in this opinion piece is the fact that in lieu of income taxes, these "vast fortunes" are instead subject to the estate tax. That tax is a flat tax of 40% of the value of the estate over about $11.7 million. (You can double that for a married couple.) So in exchange for paying the estate tax, the heirs get to skip the income tax. That tax - assuming the basis of the "vast fortune" is approximately zero - is only a maximum of 23.8% of the value. (20% long term capital gain tax rate plus 3.8% for Medicare tax on investment earnings over a low 6 figure threshold.)

For smaller estates up to about $24 million (as if $24 million as actually small), the estate tax is preferable to the income tax. But for larger estates, it is far cheaper to pay the current income taxes on their wealth than the estate tax.

But there's more. Biden's proposal also raises the top capital gain tax rate to 39.6% - matching the top rate on ordinary income. So that would make the income tax roughly match the estate tax.

So what are some potential fallouts from this change in the income tax code?

First, people will start squealing like stuck pigs over double taxation. "I have to pay both income tax AND estate tax on the same money!! That's not fair! That's double taxation!!!" Yes, it is. So what? You made way more than you needed during your lifetime, and you're heirs are still getting some significant coin. But these are influential voices - and they can afford lobbyists. So they will attempt to get the estate tax repealed, or at least get some kind of credit for the income tax that now has to be paid.

Then there's the problem of keeping track of this carryover basis. It's easy to do that for the big names - Walton, Gates, Buffet. They are the founders of their now publicly owned businesses and their investment in their business is minuscule compared to the value. But what about people like the readers here? Their wealth is more likely to be created from a lifetime of saving and investing. And your basis in your investment portfolio is not so easy to calculate. Yes, brokers are required to keep track of your basis. But that only started a little over a decade ago. Brokers weren't required to track your basis before around 2010. How do heirs get basis information from before then? If you don't take the time to spell out your basis in every single stock and mutual fund and bond you own, then update that information regularly, and then pass that information on, your heirs may end up paying more taxes than they need to. Under the tax law, if you can't substantiate your basis, it is deemed to be zero. One part of the reasoning behind carryover basis is to deal with this problem. Pay the estate tax instead of the income tax, then step up the basis to a value the heir can calculate without assistance from the deceased - who can't assist any more.

Finally, let's not forget the impact on the less wealthy. I don't see any exception to the loss of step up basis for those with less than $11 million in assets. So while you wouldn't be paying estate taxes anyway, you got to benefit from the basis step up. But with no step up, this is an increase in your taxes - more correctly, your heir's taxes - as well as those who are fabulously wealthy. Heck, it even impacts people who pass on nothing more than the family home. Mom and Dad never were wealthy, but they were able to pay off their home and retire on their small pension and social security. Now that home will get taxed when you inherit it.

This isn't just a tax on the wealthy. This is a tax on everyone.

I'm not saying that generational wealth isn't a problem. But I don't think this is a good solution to it. And the argument in favor of it almost universally overlooks the significant tax that is already being paid by only the wealthy.

If you want to work on reducing the wealth disparity in this country, a larger estate tax is a much better way to get there.

--Peter
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Someone's gotta pay for those aircraft carriers. US federal government revenue in 2018:
$0.02 trillion paid in estate and gift taxes.
$0.2 trillion taxes paid on realized capital gains.
$1.8 trillion paid on personal income.
$1.2 trillion in payroll taxes. (social insurance)

The problem is that capital gains are often taxed at zero percent. There should be a balance in taxing capital and labor. Taxing capital at zero is too low.

WHAT ARE THE OPTIONS FOR REFORM?
1. Eliminate step-up in basis at death
"Eliminating basis step-up for heirs would result in a regime called “carryover basis.” The basis of an asset would not change when bequests are made. When the asset is later sold by an heir, the taxable basis would be the same as when the decedent owned it."
2. Tax capital gains at death
3. Tax capital gains on an accrual basis
4. Retrospective taxation
https://www.brookings.edu/blog/up-front/2020/01/14/how-could...
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WHAT ARE THE OPTIONS FOR REFORM?

Why do these articles always miss the simpler solutions?

Increase the tax rate on capital gains. Tax them just like any other income. And hit them with social security taxes while you're at it. Do the same for dividends and interest.

If you want to give a break to capital gains, give it ONLY to those who are actually participating in capitalism - those who bought their shares directly from the company. That would be the founders and those who buy shares in an IPO.

--Peter
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Seems like a nightmare in paperwork. What if dad doesn’t remember what he paid for an asset 65 years ago?
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Then use a cost basis of $1.00

And tithe the 401K too
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What if dad doesn’t remember what he paid for an asset 65 years ago?

You never throw away the purchase statement until after long you've sold an asset and paid the taxes on it. Never, as in never. There should be nothing to remember.
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You never throw away the purchase statement until after long you've sold an asset and paid the taxes on it. Never, as in never. There should be nothing to remember.

I like your fantasy world.

Your advice is, of course, correct. But here in the real world it doesn’t happen all that often.

—Peter
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