We are in an election year, and the two major parties see things differently when it comes to taxation. There’s been a lot of talk about taxing the very wealthy, and one way to do this would be to alter the parameters of the federal estate tax. Let’s look at the details.
Estate Tax Exclusion
The key factor is the federal estate tax exclusion. This is the amount that can be transferred before the estate tax kicks in. When a new tax package was passed for the 2018 calendar year, the estate tax exclusion was doubled. It went from $5.49 million up to $11.18 million.
Since then, there have been adjustments to account for inflation. This year the exact amount of the federal estate tax credit or exclusion is $11.58 million. The tax carries a 40 percent maximum rate.
If the election turns out in favor of the Democrats, we could potentially see a push for a reduction in the federal estate tax exclusion. This is something to keep an eye on if you have concerns about this tax.
Step-Up in Basis
Another tax situation that could be impacted by a change in leadership is the way that the capital gains tax is treated when appreciated assets are inherited.
To explain by way of example, let’s say that your grandfather passes away, and he leaves you 1000 shares of stock. He bought the stock many years before he died, and when he purchased it, the stock was selling for $10 a share.
Your grandfather paid $10,000 for the stock initially, and he was in possession of it for 20 years before his death. Over that time, it went up in value to $100 a share. When you assume ownership of the stock, it is actually worth $100,000.
The stock went up in value by $90,000. If your grandfather would have sold the stock while he was still living, he would have been realizing a gain. As a result, the capital gains tax would have been imposed.
A short-term capital gain is a gain that is realized less than a year after the asset was acquired. These gains are taxed at your regular income tax rate. For long-term gains that are realized more than a year after the acquisition, the rate depends on your income level.
Individual taxpayers that report $40,000 or less in taxable income in the year that the gain is realized pay no capital gains taxes at all on a long-term gain. For the bracket between $40,000 and $441,450, the rate is 15 percent. Long-term capital gains are taxed at a rate of 20 percent for taxpayers that earn more than $441,450.
Getting back to the hypothetical stock inheritance, you as the inheritor would get a step-up in basis. This means you would not be responsible for the gains that took place during the life of your grandfather.
The meter starts running anew when you acquire the stock with a present value of $100,000. If you sell the stock at a profit later on, you would be responsible for the increase over $100,000.
Joe Biden’s platform includes a proposed elimination of the step-up in basis. As you might imagine, wealthy people can transfer appreciated assets with no capital gains tax consequences under the current arrangement. This is often done, so the change would be impactful.
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