The federal tax code contains a loophole so big that in the time you spend reading this article, it will have saved wealthy families and their heirs an average of about $400,000. Over the course of a day, the average total savings is more than $100 million.
Families without sizable estates may be unfamiliar with the provision, but it’s been on the books for more than 90 years and has helped the wealthy pass on billions in dollars to their descendents tax-free.
It’s known as the stepped-up basis rule, or, as President Joe Biden called it this month, the “trust fund loophole,” and Biden’s American Families Plan aims to put an end to it for many people who inherit big estates.
Biden, who advocated removing the provision while on the campaign trail, continued attacking it this month in an address he made in support of his plan.
“We need to make a choice to eliminate the loophole,” Biden said. “[If] a person passes away and leaves stock to their son or daughter, [they] don't have to pay anything on that multimillion-dollar gain when they sell that stock.”
Rep. Kevin Brady of Texas, the highest-ranking Republican on the House Ways and Means Committee, likened eliminating the stepped-up basis to a “middle-class death tax” and said the proposal punishes family-owned farms and businesses.
“It discourages family-owned businesses from investing their money back into their business or farm,” Brady said.
However, the U.S. Senate publishes a yearly report that includes an estimate of the impact of the stepped-up basis on Americans, and according to that report the top earners benefit the most from this part of the tax code.
Estates of more than $11.7 million do not benefit from the stepped-up basis and are subject to the estate tax, which taxes about 40 percent of an estate’s worth. The tax used to start at $5.6 million, but the Trump administration doubled the threshold at the end of 2017, opening the door for many affluent families to escape it. Now, fewer than 2,000 estates are potentially subject to the estate tax, according to a memo from the Congressional Joint Committee on Taxation.
The stepped-up basis provision is a benefit for heirs of estates smaller than $11.7 million. Normally, the heir to a house or a stock portfolio would have to pay a capital gains tax on the amount those assets increased in value since they were first purchased. But under the stepped-up basis provision, the increase in value is not taxed upon the death of the original owner. The moment the asset switches hands to a new generation, the appreciated value is permanently forgiven by the government.
By government estimates, the stepped-up basis provision left more than $40 billion of potential tax dollars in the pockets of wealthy heirs in 2020 alone, a figure that has steadily climbed since 2017. Five-year estimates show no sign of a reduction in that number.
“Middle-income people spend most of their assets before they die, whereas high-income people have more wealth than they can spend,” said Leonard Burman, a co-founder of the Urban-Brookings Tax Policy Center, who contributed data to the Senate’s predictions. “So the more unequal wealth becomes, the more assets you’ll find are being passed tax-free.”
The stepped-up basis provision, which has been used for decades to pass on wealth, was designed for that purpose. According to congressional records, the exemption was drafted in 1927 as a part of the Internal Revenue Act by House Ways and Means Committee Chairman William R. Green with help from Treasury Secretary Andrew Mellon, the son of one of the wealthiest families of the time.
Though the provision has widespread support among the people who benefit from it, not all of them agree. Eric Schoenberg, a member of the tax-reform advocacy group Patriotic Millionaires, said he has more than $10 million to his name. In the 1990s, he inherited his grandparents’ shares of his father’s successful tech company, making him a millionaire overnight. Since then, he has fostered his wealth as a partner in a tech-focused investment bank, making what he called “a tidy sum.”
Schoenberg said he favors throwing out the stepped-up basis rule, and supports taxing assets in full at inheritance. He concedes that getting there is a lot harder than it sounds.
Wealth, especially at the level of millionaires and billionaires, is hard to calculate. The wealthy thrive in that unknown, Schoenberg said.
“There are all kinds of games played around calculating wealth to help squeeze into these loopholes,” Schoenberg said.
In the provision’s near century-long life, no legislation has offered a justification for its existence, according to the Senate Committee on the Budget’s annual tax expenditure report, which has a long-standing section noting that the practice largely benefits the wealthy. The report speculates the rationale could be simply the supposed indecency of imposing a tax upon the death of a family member, a concern Brady echoed, or because of the mountain of administrative work that would come with collecting the taxes.
Attempts to remove the clause, which now lives in Title 26 of the U.S. Code, have repeatedly failed. In 2010, the provision — and the estate tax as a whole — was timed to expire, but Congress enacted an extension, now with no time limit.