Step Up Steps Back

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April 15, 2021

A big change to inheritance rules is on the horizon. The STEP Act (Sensible Taxation and Equity Promotion) may eliminate the step-up in basis, and it will have a significant impact on many American families. First, an overview of the issue:

Capital Gains and the Step Up in Basis

A mainstay of tax policy is the step up in basis. Here's how it works. Someone purchases appreciable property for a certain amount of money. This is called their basis. Over time, the property increases in value. This is a capital gain. When they die, their family inherits the property with a "step up" in the basis, so that the family doesn't owe capital gains taxes upon inheriting.

For instance, say you purchase a farm for $100,000. That is your basis. During your lifetime, the farm increases in value from $100,000 to $500,000. This is a capital gain of $400,000. When you die, your family inherits the farm and receives a "step up" in basis, so that their basis is not the original $100,000 but the new $500,000. This means they do not owe capital gains taxes on the $400,000 increase in value.

This may seem a little convoluted, but it's incredibly important. For many families, the main asset being transferred is not piles of cash but something more tangible - family farms and ranches, family businesses, and other real estate. Receiving a step up in basis means the family doesn't have to liquidate the property simply to pay the taxes. The value stays with the family.

Enter the STEP Act

The (ironically named) STEP Act - introduced by Senators Chris Van Hollen, Cory Booker, Bernie Sanders, Sheldon Whitehouse and Elizabeth Warren - seeks to eliminate the step-up rules and impose capital gains tax liabilities at the time of inheritance.

The bill, as currently written, seeks to tax capital gains at the time of any transfer, whether during life or at death. At death, the first $1,000,000 of gain would be excluded. This protects transfers of lesser value - like a small stock account or some real estate - from the tax loss. However, during lifetime, a completed gift to a trust or someone other than a spouse would receive an exclusion for the first $100,000 in gain but would be exposed to a transfer tax after that.

Estate planning attorneys, like us, typically start imagining how certain types of irrevocable trusts and non-grantor trusts might be used to help. But not so fast. The bill, as written, would impose transfer taxes on transfers to intentionally defective grantor trusts and would have reporting requirements for non-grantor trusts. Such trusts would be required to report all gains every 21 years. Trusts with more than $1,000,000 in assets or $20,000 in gross income would be required to provide a balance sheet, income statement, and list all trustees, grantors, and beneficiaries to the IRS. This would be a windfall for valuation companies, but the Act allows valuation costs to be included in itemized deductions.

Families who inherit illiquid property subject to the tax would have 15 years to pay the tax, but a lien would be placed on the property during that time, making it difficult (or impossible) to refinance or use the property as collateral, which is essential to running certain businesses or farms and ranches.

Oh, and another thing. This would apply to any inheritance after December 31, 2020. In other words, the bill would be retroactive.

What can you do?

There's a lot we still don't know. We need to see how the language of the bill develops as it approaches passage. Currently, transfers to charity, spouses, charitable trusts, qualified disability trusts, and cemetery trusts would still be exempt from the tax. Other strategies to reduce or eliminate the tax may be available, but we don't know enough yet to make effective proposals.

If you have assets that may be subject to this change, schedule time to meet with your estate planning attorney and financial advisor now to start strategizing.

Here's the stuff we always put at the end: If you want to know more, we would love to talk with you. Best part, the conversation about how it could benefit you doesn't cost anything. If you're in the Tulsa area, call us at (918) 770-8940, send an email to firm@tallgrassestateplanning.com, or click HERE to schedule a free consultation with a Tallgrass attorney. If you're in the Oklahoma City area, call (405) 358-3548 or send an email to howdy@tallgrassestateplanning.com.

Disclaimer: Reading this blog post does not create an attorney-client relationship, and it is not formal legal advice. This is for information purposes only. It is always best to speak with an attorney about your questions, assets, concerns, and needs.

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