On April 28, President Biden delivered a speech to a pared down joint session of Congress outlining his American Families Plan and his infrastructure package, which carry a collective $4 trillion price tag. Consistent with his campaign, Biden proposes to pay for these plans largely by increasing taxes on corporations and on high net worth Americans. However, in a break from his campaign, Biden is no longer proposing expansion of the estate tax, which currently taxes estates that exceed $11.7 million at 40 percent. Despite this omission, Biden's plans, if enacted, could have significant estate planning implications. Specifically, his proposals to increase income tax and capital gains tax, and to eliminate the step up in basis rules, should be considered when reviewing your plan.
Biden proposes raising the top marginal income tax rate from 37 percent to 39.6 percent and would increase the capital gains tax rate for individuals earning over $1 million or married couples earning over $2.5 million from 23.8 percent to 39.6 percent, which would equalize the rate paid on investment returns and wages for high earners. Biden also proposes eliminating "step up in basis," which allows an individual to bypass capital gains tax when an asset is inherited. It works by using an asset's market value at the time of inheritance rather than the initial purchase price as the cost basis for capital gains when the asset is sold.
Let's use a concrete example to show the impact of Biden's proposal to eliminate step up: your aunt purchased a cottage for $1 million in 1990 and named you as the beneficiary of this home in her Trust. This same cottage has an appraised value of $3 million at the time of your aunt's death; with a hot real estate market, you're able to sell it for $3.5 million Under current law, by stepping up the basis, you owe capital gains tax on only $500,000 – the sales price minus the appraised value at the time of your aunt's death. If step up in basis is eliminated, you would owe capital gains tax on $2.5 million – the sales price minus your aunt's initial purchase price. Compounded with an increase in the capital gains tax rate as described above, this proposal would decrease the amount of wealth that individuals are able to pass down to their desired beneficiaries.
Planning Implications and Takeaways
Specific planning opportunities will depend on your assets – how appreciated in value they are, how they are owned, and what you would like to do with those assets. It's hard to predict which of these proposals will make it through Congress, but now that Biden has released his plan, we know that it is unlikely that the increase in the gift and estate tax exemption implemented by the 2017 Tax Cuts and Jobs Act will be decreased before it is set to expire at the end of 2025. So, you likely have until then to make lifetime gifts to take advantage of the increased exemption.
Planning around the elimination of step up in basis or an increased capital gains tax rate would at this point be premature. However, you would be wise to gather a clear picture of your assets, including your basis in those assets so that if these changes are enacted, your estate planning attorney can best advise you.