How to avoid estate planning pitfalls with the new Biden policy changes

There has been considerable discussion of President Biden’s policy changes, the debate ranges from student loan debt forgiveness to the removal of the stepped-up basis in estates, and the implications of these changes.  While the discussion of student loan forgiveness is beyond this blog post, the removal of stepped-up basis is something that can be examined and discussed.

For starters, what is stepped-up basis?  Black’s law dictionary defines stepped up basis as: “Tax provision for inheritances allowing tax to be determined by market value at time of death and not at time of original purchase.”  Essentially, what the above description is telling us is that, when a person passes away, the value of the asset is determined by the fair market value at the date of death. The beneficiary then “steps-up” into the ownership of the asset as if they had acquired it at the date of death.

For instance, if a person bought a house for two hundred and fifty thousand dollars, retained ownership of the house until their passing ten years later.  The market value of the house at the date of death shows that it had appreciated to four hundred and fifty thousand.  In this instance the beneficiary could then sell the property and pay the usual costs associated with sellers.

One of President Biden’s proposals is to remove the stepped-up basis for estates.  The removal of stepped up basis alters the above hypothetical considerably.  In that instance where a person bought a house for two hundred and fifty thousand dollars and retained ownership of the house until their passing ten years later.  The market value of the house at the date of death shows that it had appreciated to four hundred and fifty thousand.  However, the beneficiary would not “step-up” into the ownership of the asset as if they had acquired it at the date of death.  Instead, they would take ownership as if they purchased the property at the original two hundred and fifty thousand dollars.  The beneficiary could then sell the property, paying the usual costs associated with sellers, but also needing to pay capital gains.

This brings us to the next point of capital gains.  Currently, the long-term capital gains tax rate is as follows:

President Biden’s plan adjusts both the taxable income amount and the tax rate itself.  The taxable income changes to approximately five hundred thousand for a single person and one million for a couple.  Any income exceeding the above-mentioned numbers would be taxed at 39.6%, with an additional 3.8% Medicare surtax on investment earnings, bringing the top rate to a total of 43.4%.

It has been pointed out that only a small percentage of people have yearly income over five hundred thousand for a single person and one million for a couple.  It should be fine, right?  This question tends to trip up so many people, because sometimes the inheritance has to be listed as taxable income.  Suddenly, taxable income goes over the amounts listed above and a sizeable tax bill is levied.

How do you avoid this scenario?  By structuring your estate plan efficiently; you can set up your assets to be distributed in a way that does not trigger the capital gains taxes.  Alternatively, you can structure your estate plan to start distributing, while you are still living, to reduce the total amount that you would be leaving to your beneficiaries.  Most plans tend to have a fusion of the two options.

It is highly advisable to discuss with a competent attorney when dealing with your Estate Plan or Trust. Call our office today at 540-443-9255, or email at [email protected] to discuss your estate planning needs with an experienced estate planning attorney.