Earlier this year, President Biden announced the American Families Plan – a series of proposed changes to the tax code that could significantly alter the way many individuals approach their estate planning.
One proposal included in the American Families Plan that has garnered much attention, especially in farming communities, is the proposal to eliminate the policy known as the “step-up in basis” upon the death of a taxpayer. This policy has traditionally allowed a taxpayer’s basis in his or her property to “step-up” to the property’s fair-market value upon the taxpayer’s death. For example, suppose a farmer buys farmland for
$5,000 per acre and later sells that farmland for $10,000 per acre. In this scenario, the farmer’s basis in the land is $5,000 per acre, and he would owe capital gains taxes on the $5,000 gain. Alternatively, suppose the farmer died owning the farmland, and upon the farmer’s death, the farmer’s beneficiaries sold the farmland for $10,000 per acre. In this scenario, the farmer’s beneficiaries would not owe any capital gains taxes because the basis in the farmland “stepped up” to the farmland’s fair-market value of $10,000 per acre upon the farmer’s death.
If the step-up in basis were eliminated, instead, the IRS would treat the death of an individual similarly to a sale and, after granting the individual a $1,000,000 exemption (or a $2,000,000 exemption for married couples filing jointly), the IRS would tax the difference between the property’s basis and its fair-market value to the individual’s estate. For example, suppose a single farmer’s basis in his or her farmland is $1,000,000 and the farmer’s beneficiaries sell the farmland after the farmer’s death for
$2,000,000. After factoring in the $1,000,000 exemption, the farmer’s estate would owe capital gains taxes on the $1,000,000 gain. Alternatively, if the farmer is married at death, there would be no tax to pay because spouses filing joint tax returns would receive a $2,000,000 exemption.
Similar to sales, most gifts (with the expected exception of gifts to spouses or charities) would also be treated as a sale, and the difference between the property’s basis and its fair-market value would be taxable to the individual. Without this inclusion, individuals could simply give away their property before death. With that said, the American Families Plan does not currently call for any changes to the $250,000 exemption
($500,000 exemption for spouses filing jointly) on gain from the sale of a personal residence. The current exclusion for capital gain on certain small business stock would also apply.
It is important for taxpayers to note that the tax on gains at death would not be the same thing as the estate tax that is currently in place, but is in addition to this tax. The estate tax taxes the value of a decedent’s estate if it exceeds a certain amount and is expected to continue as normal with the exception that the new tax on gains would be deductible from the estate value. The American Families Plan does not currently call for lowering the estate tax exemption (which is currently $11.7 million per individual). With that said, that exemption is scheduled to return to previous levels of approximately $5 million per individual in 2026, if not changed sooner by Congress.
In addition to the proposal to eliminate the step up in basis rules, the American Families Plan also calls for restoring the 39.6% individual tax rate and lowing the income thresholds to which this tax rate applies beginning in 2022. Under the proposal, the top tax rate of 39.6% would apply in 2022 to spouses filing jointly who have income in excess of
$509,301. Under c urrent law, the top tax rate of 37% doesn’t apply until spouses filing jointly have income in excess of $628,301.
Another change included in the American Families Plan involves the elimination of preferential capital gains tax rates in certain situations. Under current law, long-term capital gains (i.e., gains on assets owned by the taxpayer in excess of one year) receive preferential tax rates that top out at 20%. The American Families Plan calls for all yearly income (whether ordinary or long-term capital gain) in excess of $1 million for individuals to be taxed at ordinary rates. These rates would top out at 39.6% which is nearly double the current top rate of 20% for long-term capital gains.
An additional proposal in the American Families Plan that would likely affect many farmers is the proposal to limit 1031 exchanges to $500,000 per year (or $1,000,000 for spouses filing jointly.) Currently there is no limit to the value of tax-deferred exchanges that may be completed in a year.
After reviewing the proposals in the American Families Plan, it’s easy to understand why many individuals are concerned about how the proposals could affect them or their businesses.
Representative Cindy Axne, a Democrat, signed a letter earlier this year with 13 other Democratic farm-district Representatives urging the House of Representative to exempt family farms from any changes to the step up in basis.
Other proposed protections have included exempting family farms and other small businesses from the new tax as long as the assets remain in the family or as long as the assets are inherited by family members actively involved in the farm or other small business. The important thing to remember right now is that the American Families Plan is simply a proposal at this point. Nothing is set in stone and given how narrowly divided the current Congress is, it is unlikely the plan would be enacted without significant changes to how it is currently written.
With all that said, many taxpayers are still concerned and want to know what, if anything, they can do to minimize their tax burden if the plan is enacted. Unfortunately, until we have a better understanding of what direction the legislation will take, it’s difficult to provide specific advice.
At this point, we recommend that anyone who is concerned by the proposed changes continue to monitor the proposed legislation. If anyone has specific concerns, or if anyone wants to review their estate planning in light of the proposed changes, please do not hesitate to contact us and we will be happy to assist you.