In March 2021, U.S. Senators Chris Van Hollen, Cory Booker, Bernie Sanders, Sheldon Whitehouse, and Elizabeth Warren proposed the STEP (Sensible Taxation and Equity Promotion) Act. The goal of the proposed act is to overrule the stepped-up basis principle that currently allows individuals to inherit property without paying capital gains on assets that have increased in value.
According to the STEP Act proposal, the existing system encourages the concentration of assets in the hands of wealthy families, thus preserving financial inequality. The STEP Act’s goal is to promote equity and assisting fairer wealth distribution.
However, many of those who would feel the impact the hardest may need to develop an asset protection plan by consulting an asset protection attorney or estate planning lawyer. Read on to determine whether you may be impacted by these changes.
How Would the STEP Act Impact Capital Gains Recognition at Death?
Here is how the stepped-up basis system currently works: Mr. Bounty, a successful businessman, buys a property. The property’s value doubles or triples over the next 20 years, with capital gains amounting to many millions. If Mr. Bounty sold this property during his lifetime, he would have to pay substantial income tax.
However, according to the current tax system, if the assets should remain in Mr. Bounty’s hands until his death, his heirs would not have to pay income tax on the property’s appreciation in value. For tax purposes, the worth of the assets “steps up” upon inheritance, allowing the Bounty legacy to pass on the family property intact.
If the STEP Act passes in its current form, this picture will change considerably. The new legislation would require heirs to pay transfer tax on any capital gain over $1 million.
For example, let’s say Mr. Bounty’s daughter inherits property worth $10 million. When the late Mr. Bounty had bought the asset, it had been worth $5 million, so he had gained $5 million upon it. However, Mr. Bounty never paid capital gains taxes on the $5 million gain in property value.
In this scenario, after Mr. Bounty’s death, $1 million in capital gains would be exempt from capital gains tax, and Ms. Bounty, the daughter, would need to pay capital gains taxes for $4 million of the inherited property’s wealth appreciation. Under the current system, she would not pay any capital gains taxes on those gains (nor had her father).
If Passed, How Will The STEP Act Affect You?
Understandably, the STEP Act has elicited much criticism. If it passes, its impact will carry far beyond the wealthiest U.S. citizens. In today’s economy, limiting tax exemption to $1 million in accrued capital gains on inheritances would mean that many families would end up paying a sizable tax on their inherited legacy.
These capital gains tax rules apply not only to real estate, but also to other investments such as ownership interests in a business, stocks, and brokerage accounts. Under the STEP Act, the $1 million capital gains exemption is not per asset, but rather, is in aggregate, meaning if you own a home that has increased in value by $350,000 and investments that have grown in value by $800,000 for total asset growth of $1,150,000, then $150,000 will be subject to capital gains tax after subtracting the $1 million exemption. Thus, small business owners, farmers, and individuals living in areas with high property values and similar could be especially hard hit if the STEP Act is passed.
Farmers’ organizations have been especially vocal in their resistance to the STEP Act proposal. As the old saying goes, farmers who are “land rich and cash poor” may own extensive real estate and farm equipment but at the same time struggle with high expenses and unstable incomes. If the heirs of a farming business have to pay capital gains tax on real estate their parents had purchased many decades ago, they might be unable to afford to keep the family farm.
Although we hope that the STEP Act will undergo improvements before it passes, investing in estate planning ahead of time is essential. An asset protection attorney can help you understand the implications of the STEP Act and how it applies to your situation.
Seven Essential Facts About the STEP Act
Here are a few more things you should know about the STEP Act:
1. It would create a tax increase for high-income filers. Tax filers with a taxable income higher than $400,000 would pay an income tax rate of 39.6%. This could mean an annual tax increase equaling hundreds of thousands of dollars for the wealthiest American households.
2. It proposes introducing a 12.4% (an additional 6.2%) Social Security Payroll Tax on earned income above $400,000.
3. It would bump up the Corporate Income Tax to 28%, compared to the 21% the TCJA (Tax Cuts and Jobs Act) established in 2018.
4. It will probably increase the Corporate Minimum Tax from 21% to 28% under Biden’s administration.
5. It would establish a Corporate Minimum Tax on book income instead of taxable income (income after write-offs, loss carryovers, and special deductions). The change would apply to corporations with a book income of at least $100 million.
6. It would double the tax rate on Global Intangible Low-Taxed Income (GILTI), imposing a tax rate of 21% compared to the current 10.5%. This part of the STEP Act would primarily apply to controlled foreign corporations.
7. It would temporarily increase the amount of child tax and dependent credit. This provision would count as a temporary measure applicable during the COVID-19 national crisis.
Estate Planning Attorney and Founder of Carolina Family Estate Planning, Jackie Bedard, and Her Team Can Help You Plan for the STEP Act
At our law firm, we help families build better lives by planning for a secure future via estate planning, asset protection, and long-term care planning. If you are unsure about the details of your will or the future of your family estate, we’re here to help you get your ducks in a row.
Are you looking for a trust and estate attorney in the Wake County, NC area? Schedule a needs assessment call with our experienced, caring, and dedicated legal team at Carolina Family Estate Planning at 919-443-3035 or complete our online form. We look forward to setting up a vision meeting with you to discuss your estate planning goals.
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