A phrase from the famous philosopher named Heraclitus of Ephesus around the year 500 BC. “Nothing in life is permanent, nor can it be, because the very nature of existence is change.”
It’s with this phrase in-mind that we discuss the possible tax changes that may lie ahead; eliminating the step-up in basis, increasing capital gains, and/or reducing of the estate tax exclusion.
Under current law, assets that pass directly to heirs benefit from a step-up in basis. This means the heir receives the asset valued as of the date of death. If the heir sells this holding right away, they pay little to no capital gains taxes.
Biden’s proposal would tax an asset’s unrealized appreciation at transfer, referred to as eliminating the step-up in basis.
In addition, the proposal is also set to increase the capital gains tax rate from 23.8 percent to 39.6 percent for high income earners. When including the net investment income tax, the top federal rate on capital gains would be 43.4 percent. What would have previously been a tax-free transfer at death is now not only proposed to be taxable, but at a higher rate!
Combine that with a reduced estate tax exclusion and it could be a triple-whammy. Currently this exemption is $11.7 million per individual and $23.4 million per couple. Biden’s proposal is to drop that limit to $3.5 million per individual, in which an amount of the estate above the limit would be taxed at a 40% rate. To put that in perspective, an estate of $5 million (currently under the $11.7 million limit) would be taxable for amounts over $3.5 million at a 40% rate.
Each one of the proposals, on their own merits, has curious implications. But the picture looks dramatically different if all three were to happen.
Going forward, the biggest opportunity to avoid tax is the exception within life insurance, as the proceeds are not includible in the recipient’s gross income. People will need to start rethinking the way they manage their investments, and their estate plans and life insurance will take center stage for those who want a tax-friendly way to pass on wealth. When structured appropriately it will provide liquidity needed to pay for any taxes at death.
Please call one of our life insurance experts to discuss in greater detail, we are here to help!