Will inheritances be subject to new taxes?

The current estate tax exemption for 2015 is $5,430,000. That’s a powerful estate-planning tool. It spares qualifying estates from the hassle of filing an estate tax return and paying estate taxes on transferred property. 

However, the Obama administration might be considering a revision to one aspect of estate planning: doing away with the step-up basis applied to inherited assets. 

Notably, President Obama referred to the current step-up approach as a trust fund loophole. To be precise, however, the step-up basis refers to the current approach to capital gains taxes, not estate taxes. When a capital asset is sold, any gain or loss is usually subject to capital gains tax. That tax is determined based on the asset’s basis and its sale price. Accordingly, when a beneficiary sells an inherited asset, capital gains tax is usually triggered.

Under current law, a beneficiary’s inherited asset is valued at its fair market value at the date of inheritance. That’s usually a higher value than what a decedent paid for an asset, especially if the asset was purchased a long time ago. Thus, if a beneficiary sells an inherited asset, any profit is calculated based on the difference between the sale price and the stepped-up basis, set at fair market value. That makes for a lower profit, at least on paper, and lower capital gains tax than if the profit were calculated based on the decedent’s basis.

Yet if the step-up approach were eliminated, the ironic result might be even more trusts utilized in estate planning. After assets have been transferred to an irrevocable trust, the grantor is no longer the owner. When he or she dies, a taxable event won’t trigger capital gains tax because the trust is the owner of the assets.

Source: Forbes, “Obama Attack On ‘Trust Fund Loophole’ Could Increase Tax Advantage Of Trusts,” Janet Novack, Jan. 20, 2015

Source: Internal Revenue Service, “Topic 409 – Capital Gains and Losses”