Under current law, heirs don’t have to pay tax on the capital gains that were accrued by an asset or investment before they received it. They only have to pay capital gains taxes on an inherited asset after they sell it, and they only have to do so for the amount the asset or investment appreciated after it came into their possession.
Democrats, led by Senator Chris Van Hollen (D-Md.), say it’s time for that to change.
Van Hollen has joined with Senators Elizabeth Warren (D-Mass.), Bernie Sanders (I-Vt.), Cory Booker (D-N.J.) and Sheldon Whitehouse (D-R.I.) to introduce a proposal to close what they call the “stepped-up basis loophole by taxing the unrealized capital gains of fortunes on which the original owner never paid income or capital gains taxes.”
“The stepped-up basis loophole is one of the biggest tax breaks on the books, providing an unfair advantage to the wealthy heirs every year. This proposal will eliminate that loophole once and for all. It’s time to stop subsidizing massive inheritances for the rich and start investing in everyday Americans,” Van Hollen said in a statement Monday afternoon.
Warren said it would close a loophole “on huge, inherited fortunes for the wealthiest Americans” and get “the wealthy and well-connected to pay their fair share.” The proposal would exempt $1 million in unrealized gains per individual or $2 million per couple from taxes.
Currently, wealth that is passed on after death is only subject to the estate tax, for which there is a large exemption of more than $11 million per person or $22 million per couple.
Under Van Hollen’s plan, a $1 million stock purchase made by a deceased individual in the year 2000 that had increased to $5 million by the year 2021, and thereby enjoyed a gain in value of $4 million, would be subject to a 23.8-percent tax on $3 million in unrealized capital gains.
Such an amount would be subject to the top capital gains rate of 20 percent and the 3.8 percent net investment income tax that was enacted as part of the Affordable Care Act.
If the asset were jointly held by a deceased couple, the tax would fall on $2 million in unrealized gains, with the other $2 million being exempt. “The exclusion applies to the deceased, not the heir. Each decedent gets $1 million exemption for unrealized capital gains,” said a Senate aide familiar with the proposal.
Jim Kessler, executive vice president for policy at Third Way, a centrist Democratic think tank, said higher taxes on unrealized capital gains is likely to be a core component of the Democratic agenda under President Biden. “It is inevitable that Democrats are going to do something on unrealized gains, and stepped-up basis is a prime suspect for action,” he said.
The White House is circulating a plan to raise $3.5 trillion in tax revenue over the next year to offset the cost of a potentially $4 trillion infrastructure plan.
The Van Hollen proposal would raise around $400 billion over 10 years. It would not apply to 401(k) retirement plans that are generally exempt from capital gains taxes after death unless it is part of an estate that exceeds the $11 million threshold for individuals or $22 million for couples.
Gains of up to $250,000 per deceased individual or $500,00 per deceased married couple from the sale of a principal residence would also be exempted.
The proposal sparked immediate criticism from Americans for Tax Reform, a group that advocates for smaller government and lower taxes.
“This has been tried before (1976) and it was such a debacle Congress repealed it. It’s damn near impossible to determine basis for many decades-old assets owned by now-deceased persons. Democrats have no idea the blowback they are about to receive,” tweeted John Kartch, a spokesman for the conservative group.
Kartch said some Californians would be subject to a 56.7 percent capital gains tax at death.
The taxes on the unrealized gains of inherited assets that are not actively traded, such as businesses, could be spaced out over 15 years under Van Hollen’s plan. But once an asset is liquidated, the unpaid tax is due immediately.
The proposal, known as the STEP Act, has the backing of groups such as the AFL-CIO, the American Federation of Teachers, Americans for Tax Fairness, and the American Federation of State, County and Municipal Employees.✪
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