As this dismal election season slouches towards Gomorrah, we examine the candidates’ positions on two issues familiar to San Francisco Bay Area trust and probate attorneys—the federal estate tax and the “step up” basis rule for capital gains.
The federal estate tax is a tax levied upon a person’s estate at their death. (Some states have additional estate and inheritance taxes, but California does not.) The tax is applied only to amounts above the “unified credit.” For 2016, the unified credit is $5.45 million per person, which means each person can give that amount away—during their lifetime or at death—without paying federal estate tax. While estates of this size are rare in many parts of the country, probate lawyers in San Francisco see them more frequently as the value of Bay Area real estate has skyrocketed.
Although the estate tax brings in less than 1% of federal tax revenue, it is a political football and a hot button issue that touches the core “beliefs” of both parties. To Democrats it is a way to reduce income inequality and the accumulation of wealth by the richest Americans. To Republicans, it is unfair to tax savings already taxed once, even twice, and will punish entrepreneurs and small business who save and work hard to pass their businesses on to their children.
Not surprising, then, that Clinton wants to raise the estate tax and Trump wants to eliminate it.
According to the Hillary Clinton website:
Hillary is proposing to restore the Estate Tax to 2009 parameters, which would ensure some of the largest, multi-million dollar estates are not exempt from paying their fair share. And she would go beyond that for estates valued in the tens or hundreds of millions of dollars. She will also close complex loopholes, including methods that people can now use to make their estates appear to be worth less than they really are. The Estate Tax is a tax on the very largest estates that would only affect 4 out of every 1,000 estates after Clinton’s reforms.
According to the Donald Trump Website:
The Trump Plan will repeal the death tax, but capital gains held until death and valued over $10 million will be subject to tax to exempt small businesses and family farms. To prevent abuse, contributions of appreciated assets into a private charity established by the decedent or the decedent’s relatives will be disallowed.
The Wall Street Journal reports that Clinton’s plan would “tax all estates over $10 million at 50%, apply a 55% rate on estates over $50 million, and go to 65% on assets above $500 millon.”
Whoever wins, it seems unlikely that either plan would get through a divided Congress without significant modification. And whatever new law emerges, estate planning attorneys would have little difficulty adjusting to a higher or lower unified credit.
More problematic would be a change in the stepped-up basis rule. To oversimplify, this rule adjusts the basis (the price at which an asset was purchased) of an appreciated asset from the fair market value when it was acquired to its fair market value at the date of death if the owner holds it until his or her death.
For example: Husband and wife purchase stock (or real estate, or gold, or a painting, or anything else) worth $10,000 and hold it throughout their 50-year marriage. After 50 years, if the stock appreciated to $200,000, the couple would have a capital gain of $190,000 (the difference between the stocks basis and its fair market value). If they sold the stock during their joint lifetimes, they would pay both state and federal taxes on that $190,000 capital gain, depending on their income tax bracket.
If the couple held the stock until one of them died, the basis of the stock would be “stepped- up” to its fair market value at the date of the first death, thereby eliminating all capital gains taxes. This allows a surviving spouse a once-in-a lifetime opportunity to sell assets and diversify their portfolio without paying capital gains taxes. (This is why San Francisco and Alameda County trust attorneys often advise couples to hold onto appreciated real estate until the first death.)
Whether this is fair or not is in the eye of the beholder. But I think it’s fair to say that the step up basis rule is adored by many CPAs and trust attorneys because it eliminates the need to determine the basis of stocks that may have been held for decades. Eliminating the step up basis rule will significantly increase the time and expense of both probate and trust administrations, particularly in more affluent communities.