Should stepped-up basis of inherited assets be restricted or abolished?

[pb4uski]

This poll arises from a debate in another thread regarding stepped-up basis. Under current law most inherited assets get a stepped-up basis to the fair value of the asset as of the decedent's date of death and any unrealized gains at the date of death never get taxed (and to be fair any potential benefit of unrealized losses is lost). Stepped-up basis is widely considered to be a tax loophole that primarily benefits wealthy individuals and families

So for example, if one inherits certain assets worth $2 million that the decedent had a $1 million cost basis then the $1 million unrealized gain never gets taxed. This would apply to most investments, a family farm, a family business and many other assets but does not apply to retirement accounts or annuities.

Historically, the quid pro quo for step-up in basis was that there was an estate tax paid. So for example, if you were the sole beneficiary of a $2 million estate where the decedent had a $1 million cost basis in 2000 the estate would have paid $220,750 (11.0%) and you would receive $1,779,250 with a stepped up basis. However, the estate tax exemption was increased to $11.18 million in 2018 and was indexed for inflation and is now almost $14 million (almost $28 million for a married couple) so the estate tax is effectively irrelevant for those other than the ultra-rich, resulting in a bonanza for beneficiaries of estates under the exemption limit.

Consider a decedent that has $2 million in stock investments in a taxable account with a basis of $1 million. The $1 million of unrealized gains is never taxed under current law and no estate tax is paid and the beneficiary's cost basis is $2 million. OTOH if the decedent's $2 million of stock is in a traditional IRA with a $1 million basis then the entire $2 million (plus any growth) is taxed when it is withdrawn by the beneficiary over 10 years.

This feature costs the government an estimated $50-60 billion annually. The Joint Committee on Taxation estimated the cost at $59.7 billion and the OMB estimated the cost at $51.9 billion for FY2024.

While there are many possible solutions the key question at hand is: Is stepped-up basis a big enough loophole in the tax law that something should be done?

 

[TheWizard]

Sounds like an inherently political question.
I voted to leave things the way they are.
But I'm a moderately wealthy person voting for my own interests...

 

[Dash man]

This would destroy family businesses including family farms.

 

[pb4uski]

Sounds like an inherently political question.
I voted to leave things the way they are.
But I'm a moderately wealthy person voting for my own interests.

It is not intended to be political at all, other than tax policy and public policy is inherently political to some extent. There is no pending legislative changes to my knowledge.

 

[pb4uski]

This would destroy family businesses including family farms.

How would eliminating stepped up basis destroy family businesses?

Perhaps you read into the question that the estate tax would be changed and that wasn't addressed at all... just stepped up basis would be reduced or eliminated.

 

[SnowballCamper]

Isn't the current plan to replace the IRS with the ERS? just sayin...

 

[tulak]

Go for it.

It’ll impact my heirs, but not excessively. Even if it did, that’s ok, they’ll still get a decent amount.

 

[TheWizard]

This would destroy family businesses including family farms.

With large family businesses, I think the strategy is to buy significant LIFE INSURANCE on the (primary) owner so that inheritance taxes are all taken care of.
Same could be done if stepped up basis went away...

 

[pb4uski]

Agree, life insurance on the principal owners is a strategy for providing liquidity for estate taxes but is less needed now that the estate tax exemption is so high.

To be clear, changes to stepped-up basis do NOT necessarily mean a change to estate taxes. If Congress desired, they could leave estate taxes as is but reduce or abolish stepped up basis so that wouldn't impact businesses at all but it would change the taxation where such business interests are sold.

 

[SnowballCamper]

With large family businesses, I think the strategy is to buy significant LIFE INSURANCE on the (primary) owner so that inheritance taxes are all taken care of.
Same could be done if stepped up basis went away...

But wouldn't the owner have to pay the tax on the asset gains to use them to purchase the life insurance?
To me the whole plethora of rules, deductions, exceptions is a total mess. To pick one out at this point is kinda pointless-- how much will it change the 36 trillion debt? I voted don't care.

 

[pb4uski]

No, where this strategy is used the life insurance premiums are paid from cash flows.

 

[CaliKid]

I like the stepped up basis at death for simplicity. It can be close to impossible to determine really old basis for many assets. A step up simplifies that.

On the other hand I would have no problem with a lower federal estate tax exemption. Letting individuals pass $10m tax free is a pretty high amount in my opinion. Seems like just yesterday it was a $600k exemption... although I suppose it was 20 years ago!?

 

[youbet]

With large family businesses, I think the strategy is to buy significant LIFE INSURANCE on the (primary) owner so that inheritance taxes are all taken care of.
Same could be done if stepped up basis went away...

Frequently not a workable idea. Say you start a business at 50 and it grows during your 50's and by 60 is valued at 5 million. Good luck paying the premium on 2 million of life insurance, taken out at 60, especially if you have any health issues whatsoever.

Family friends who farm 1100 acres here in Illinois have a very small basis. I can't imagine them being able to afford the premiums on a multi-million dollar life insurance policy. They're my age. More likely, they'd sell half the place to Bill Gates (owns 250k acres already) or the Chinese (384k acres) and stay on the other half.

 

[Chuckanut]

Could we treat inherited wealth somewhat like a non spouse inherited IRA and spread the tax out over ten years?
I don’t know what the ramifications of that would be on the family business or farm.

 

[socca]

How would eliminating stepped up basis destroy family businesses? ...

Regarding American farmland:
(1) tends to be a good inflation hedge. Over decades large unrealized capital gains can accumulate. My family recently sold some farmland from an irrevocable trust where the basis was almost zero in comparison to the sale price. This land was acquired in the 1940s.
(2) farmland is much more difficult to sell than stocks or bonds. You often can't just peel off some acreage to sell separately in order to raise money to pay the capital gains tax that would result if stepped-up basis were eliminated. The executor would have to sell the entire farm.

 

[SevenUp]

This feature costs the government an estimated $50-60 billion annually.

Said another way, this feature saves taxpayers an estimated $50-60 billion annually.

 

[socca]

One interesting thing I learned recently is that when a spouse creates a QTIP trust for a surviving spouse, the basis of the assets in the trust is stepped up when the surviving spouse dies. If the surviving spouse outlives the grantor spouse by decades, this deferral of basis step-up can be a huge benefit for the successor beneficiaries (usually the kids of the grantor spouse from a prior marriage).

 

[FlaMariner]

Why do we tax any capital gains? So many loopholes today...especially with real estate.

I like the idea of funding the government with tariffs.

 

[TheWizard]

Why do we tax any capital gains? So many loopholes today...especially with real estate.

I like the idea of funding the government with tariffs.

Oh dear...

 

[frayne]

What is the reason for the question? A $60 billion dollar savings to Uncle Sam is only about 1% of the annual budget.

 

[USGrant1962]

...
This feature costs the government an estimated $50-60 billion annually. The Joint Committee on Taxation estimated the cost at $59.7 billion and the OMB estimated the cost at $51.9 billion for FY2024.
...

The framing of "costs the government" presumes it is the government's money. It is not. As SevenUp said:

Said another way, this feature saves taxpayers an estimated $50-60 billion annually.

If the estate tax was eliminated I wouldn't be opposed to capital gains being taxed at regular rates upon death or treated like inherited IRAs to the heirs (must liquidate within 10 years and pay the LTCG taxes). But that's not the same as 40% of assets being confiscated after some apparently random exclusion amount (depending on the most recent Congress). And estate taxes don't just tax gains - they double tax the basis of assets as well.

 

[luckydude]

May I suggest that this topic belongs in the Fire Related Public Policy forum and not Fire and Money forum.

 

[ERD50]

With large family businesses, I think the strategy is to buy significant LIFE INSURANCE on the (primary) owner so that inheritance taxes are all taken care of.
Same could be done if stepped up basis went away...

It's just robbing Peter to pay Paul, a shell game. On average, the insurance company will take more money from you than you pay to them.

It does provide liquidity, but at a significant cost.

 

[pb4uski]

... If the estate tax was eliminated I wouldn't be opposed to capital gains being taxed at regular rates upon death or treated like inherited IRAs to the heirs (must liquidate within 10 years and pay the LTCG taxes). But that's not the same as 40% of assets being confiscated after some apparently random exclusion amount (depending on the most recent Congress). And estate taxes don't just tax gains - they double tax the basis of assets as well.

I agree with you on the first part of taxing unrealized gains and eliminating the estate tax or even spread the tax on the unrealized gain over 5 or 10 years. If we did that then stepped up vasis is justifiable.

On the second part, the 40% estate tax rate is a red herring because it's really 0% on the first $14 million of estate value ($28 million for a couple) and then 40%. That said, I agree that 40% is excessive, as is the $14 million exemption.

 

[pb4uski]

What is the reason for the question? A $60 billion dollar savings to Uncle Sam is only about 1% of the annual budget.

The savings is just one point of information and secondary to the whole issue. I'm not sure there is anything I can say that makes the reason for the question more obvious so I suggest that you read the OP and the thread responses.