By Brian E. Ravencraft, CPA, CGMA, Partner at Holbrook & Manter, CPAs
I usually stay clear of highly charged political topics, but I believe this one is worth mentioning. What I am about to explain has not been introduced to Congress (and timetable is uncertain), but the topic is part of President Biden’s tax plan.
Up to this point and with changes made back in 2017 tax legislation, very few people end up paying estate taxes, or even having to worry about it at all. With President Biden’s tax plan, however, a potential and massive change in how estate taxes are calculated could be on the horizon.
Biden’s plan could leave you paying higher income taxes after death by repealing present law’s step-up in basis that increases the tax basis for inherited assets to their full fair market value upon death. This proposed rule — which “carries over” an asset’s tax basis to the heir — likely would entail a significantly greater overall tax burden with respect to transferred assets than would the decreased exemption. (Currently the estate and gift tax exemption is $11.58 million per person in 2020 — and this amount is also expected to be reduced by 50% as part of Biden’s plan).
The current tax law benefits all heirs, including those receiving modest assets such as decedents’ farmland, residences or stock shares from estates valued below the estate tax threshold. For generations, assets held at death have received a stepped-up basis — to market value — when you die. At that point in time any potential tax on the appreciation disappears under present law (assuming your gross estate is under the exemption amounts). Small businesses and farmers count on this as part of their overall estate and succession planning.
A parent purchased 200 acres of land for $200,000 ($1,000 per acre). When the parent passes, the value of the land has grown to $8,000 per acre or $1.6 million. Under the current law, the child would inherit the land with a stepped-up basis of $1.6 million. If the child sold the asset a year later and it was valued at $1.75 million, the child would pay capital gains tax on $175,000 in profit.
Under the Biden plan, the child would inherit the asset at the price that the parent purchased it, or $200,000. If the child sold a year later after the parent’s death at $1.75 million, they would pay capital gains on $1.55 million (and the capital gains rate may change too. So in this case, you could potentially pay taxes on $1.55 million at potentially 39.6%)
Additionally, there is speculation that the new administration would look to change the triggering event for capital gains tax. Typically, capital gains must be paid when the asset is sold for a profit. The Biden plan is seeking to classify capital gains as realized whenever and asset or property changes hands. This means that inheritors would most likely have to pay capital gains taxes up to 39.6% every time the property passes on to another generation. This could certainly harm multigenerational farms by limiting the next generation’s success due to the tax burden.
Certainly, wealthier people are concerned that a Biden administration could make estate and gift tax changes retroactive to Jan. 1, 2021. While this is not common legislative practice, in anticipation, some folks are looking to make big gifts now to take advantage of the gift tax exemption by basically saying “If I didn’t give it away earlier, I should do it now. If the change to the estate tax is not retroactive, then I’m better off. If it is retroactive, then I’m no worse off than I am now.”
I think this strategy could have some merit if your estate is above the current exemption amount of $11.58 million. For others below the current exemption threshold, I do not propose or suggest that folks go out and take immediate action based on something that has not occurred, but I think it is a good idea to review your estate and succession plans. You should work with your accountant and attorney in tandem to develop a few viable options. This way you can stay nimble and make sound decisions should President Biden’s tax plan start to get traction.
Brian E. Ravencraft, CPA, CGMA is a Principal with Holbrook & Manter, CPAs. Brian has been with Holbrook & Manter since 1995, primarily focusing on the areas of Tax Consulting and Management Advisory Services within several firm service areas, focusing on agri-business and closely held businesses and their owners. Holbrook & Manter is a professional services firm founded in 1919 and we are unique in that we offer the resources of a large firm without compromising the focused and responsive personal attention that each client deserves. You can reach Brian through www.HolbrookManter.com.