President Biden has rolled out two major “infrastructure” proposals in the last few weeks. It’s hard to keep track of all the stimulus programs, let alone their names, so we’ll catch you up. The American Jobs Plan would raise funds for physical infrastructure (along with some non-physical “infrastructure”), for which the President hopes to garner bipartisan support. It would be paid for largely with higher corporate taxes. Republicans generally would like it to be much smaller in order to earn their support.
The American Families Plan is intended to address “human infrastructure,” such as education, employment support, and tax credits for low earners. Funding for the $1.8 billion price tag (over 10 years) is proposed to come from higher income tax rates, elimination of the private-equity “carried interest” tax loophole, limitations on 1031 real estate exchanges, dramatically higher capital gains tax rates, and changes to the estate treatment of unrealized gains. It is not anticipated to garner (any) bipartisan support.
As these are merely White House proposals, the ink is still considered very wet. Congress will now pick them up and start tearing them up and down. That said, if these were to pass as is, they would dramatically change how we manage capital gains and intergenerational wealth planning. Right now, when folks pass away, their investments outside of tax-sheltered accounts pass to beneficiaries with a stepped-up cost basis. For example, let’s assume a widow has a stock that she acquired for $5,000 in 1965, and now it is worth $100,000. Upon her death, the cost basis changes from $5,000 to $100,000 (date of death value). Thus, the “unrealized gain,” meaning the amount of potentially taxable gain on her holding would change from $95,000 to $0. If she had sold the stock prior to death, she would have paid capital gains tax on $95,000 of gains. But since she didn’t, her heirs can sell the stock (if they choose) for $0 capital gain.
Under Biden’s proposal, unrealized gains as of date-of-death would be taxed at the capital gains tax rate (which is proposed to double to 39.6%++), with an exemption of $1 million per person or $2 million per couple (an additional $500,000 of exemption applies to the deceased’s personal residence). So the widow’s $95,000 of unrealized gain would not be taxed because it fits easily under the $1 million exemption. If, instead, she had 20 stocks with similar gains, she would owe capital gains taxes on $900,000 (20 * $95,000 less $1 million).
Obviously there is a lot of uncertainty with how this will end up looking once Congress has its shot, and there are many unanswered questions, such as spousal inheritance exemption and whether lifetime (or annual) gifting use up the $1 million exemption. It is also uncertain whether the tax measures would become effective upon passage, or retroactive to the beginning of the year, or on some future date. But we would advise to take the proposal seriously.
Does this mean you should sell your low cost basis stock now at a (low) capital gains tax rate and buy it back, all in order to avoid paying a higher tax on those gains in the future? This seems premature. But if you know you’re going to need to raise cash in the near future, and low cost-basis stock is what you planned to sell (perhaps for diversification, or because that’s all you have to sell), you might consider raising that cash before passage.
If you anticipate having unrealized gains of over $1 million or $2 million upon your death, what else could you do to avoid these taxes? At this point, it appears the best two answers would be to: 1) consider charitable giving as part of your estate, and 2) talk to your estate planner. We will be monitoring this closely; don’t hesitate to reach out to us if you want to talk.