Step up in basis and estate tax

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solarcub
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Step up in basis and estate tax

Post by solarcub »

I have seen talk about eliminating the step-up in basis when a person dies, but I haven't seen a clear explanation of how it actually works anywhere. Here are my questions:

1) Under current law, if a person dies with $1 billion worth of stock, doesn't that get taxed at basically 40% before it gets passed on to the heir? So the heir would get roughly $600 million? (I am ignoring the exemption amount for rounding purposes, because it is << $1 billion)

2) Further, let's assume the $1 billion in stock had a $100 million basis. Under current law, the heir would get $600 million, but the basis would also get stepped up to $600 million, so if they sold right away, they would owe no taxes. Is this correct?

3) Finally, if the step up in basis is eliminated, then the heir would get $600 million, with a $60 million basis, so if they sold the stock they would have a capital gain of $540 million, is that correct?
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Lee_WSP
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Re: Step up in basis and estate tax

Post by Lee_WSP »

That's correct, but there aren't that many billionaires.

The step up basis was due to the fact that the exemption used to be a million dollars and even less earlier. This snagged many middle class families, so the step up was introduced. No comment on the wisdom of the solution.
random_walker_77
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Re: Step up in basis and estate tax

Post by random_walker_77 »

solarcub wrote: Tue Oct 26, 2021 4:53 pm I have seen talk about eliminating the step-up in basis when a person dies, but I haven't seen a clear explanation of how it actually works anywhere. Here are my questions:

1) Under current law, if a person dies with $1 billion worth of stock, doesn't that get taxed at basically 40% before it gets passed on to the heir? So the heir would get roughly $600 million? (I am ignoring the exemption amount for rounding purposes, because it is << $1 billion)

2) Further, let's assume the $1 billion in stock had a $100 million basis. Under current law, the heir would get $600 million, but the basis would also get stepped up to $600 million, so if they sold right away, they would owe no taxes. Is this correct?

3) Finally, if the step up in basis is eliminated, then the heir would get $600 million, with a $60 million basis, so if they sold the stock they would have a capital gain of $540 million, is that correct?
That's pretty close. Note that discussion of pending legislation is off limits, but these questions are ok.

1) Yes, ignoring the exemption, they basically owe 40%. Note that the estate really has $1B with a basis of $1B, and they first need to pay that estate tax of 40%. No need to go reconstruct basis from the records of the deceased, and if sold immediately, basically no capital gains.

2) yes

3) yes, as long as they can prove the basis is $60M. It's unclear to me if the funds used to pay the estate tax need to also pay capital gains tax, in which case the beneficiaries get less than $600M.
JackoC
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Re: Step up in basis and estate tax

Post by JackoC »

random_walker_77 wrote: Tue Oct 26, 2021 5:07 pm
solarcub wrote: Tue Oct 26, 2021 4:53 pm I have seen talk about eliminating the step-up in basis when a person dies, but I haven't seen a clear explanation of how it actually works anywhere. Here are my questions:

1) Under current law, if a person dies with $1 billion worth of stock, doesn't that get taxed at basically 40% before it gets passed on to the heir? So the heir would get roughly $600 million? (I am ignoring the exemption amount for rounding purposes, because it is << $1 billion)

2) Further, let's assume the $1 billion in stock had a $100 million basis. Under current law, the heir would get $600 million, but the basis would also get stepped up to $600 million, so if they sold right away, they would owe no taxes. Is this correct?

3) Finally, if the step up in basis is eliminated, then the heir would get $600 million, with a $60 million basis, so if they sold the stock they would have a capital gain of $540 million, is that correct?
That's pretty close. Note that discussion of pending legislation is off limits, but these questions are ok.

1) Yes, ignoring the exemption, they basically owe 40%. Note that the estate really has $1B with a basis of $1B, and they first need to pay that estate tax of 40%. No need to go reconstruct basis from the records of the deceased, and if sold immediately, basically no capital gains.

2) yes

3) yes, as long as they can prove the basis is $60M. It's unclear to me if the funds used to pay the estate tax need to also pay capital gains tax, in which case the beneficiaries get less than $600M.
How it works now is clear so I agree with 1 and 2. There isn't really an absolutely clear answer to 3 because it could depend on exact mechanics under the general heading 'eliminating the basis step up'. But the baseline assumption IMO would be that the estate first must recognize all the gains and pay tax on them, lets say at 20% on $900mil, $180 mil but therefore raising the basis on all remaining assets to market. Then the estate would pay estate tax on the whole $1bil*, $400mil. There's no such thing now as a deduction in the estate tax for capital gains tax paid** or vice versa, so if that remained the case the estate would owe $580mil in tax, heirs would receive $420mil with basis $420mil.

*ignoring the small amount less than exemption
**there is a deduction allowed for later withdrawals from an inherited IRA from an estate that paid estate tax, so that kind of mechanism couldn't be ruled out.
MarkNYC
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Re: Step up in basis and estate tax

Post by MarkNYC »

solarcub wrote: Tue Oct 26, 2021 4:53 pm I have seen talk about eliminating the step-up in basis when a person dies, but I haven't seen a clear explanation of how it actually works anywhere. Here are my questions:

1) Under current law, if a person dies with $1 billion worth of stock, doesn't that get taxed at basically 40% before it gets passed on to the heir? So the heir would get roughly $600 million? (I am ignoring the exemption amount for rounding purposes, because it is << $1 billion)

2) Further, let's assume the $1 billion in stock had a $100 million basis. Under current law, the heir would get $600 million, but the basis would also get stepped up to $600 million, so if they sold right away, they would owe no taxes. Is this correct?

3) Finally, if the step up in basis is eliminated, then the heir would get $600 million, with a $60 million basis, so if they sold the stock they would have a capital gain of $540 million, is that correct?
If and when the law is ever changed, I doubt it will work in the way that you describe.
AlohaJoe
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Re: Step up in basis and estate tax

Post by AlohaJoe »

Lee_WSP wrote: Tue Oct 26, 2021 5:03 pm That's correct, but there aren't that many billionaires.

The step up basis was due to the fact that the exemption used to be a million dollars and even less earlier. This snagged many middle class families, so the step up was introduced. No comment on the wisdom of the solution.
This isn't how the step up basis came into existence.

It has always been there, since the very beginning of The Revenue Act of 1916. It wasn't instituted later as a way to save struggling middle class families.

Indeed, you used to get a step up basis on gifts as well as bequests. That was eliminated in 1921 but the bequest step up basis doctrine remained.
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gobel
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Re: Step up in basis and estate tax

Post by gobel »

MarkNYC wrote: Tue Oct 26, 2021 7:18 pm
solarcub wrote: Tue Oct 26, 2021 4:53 pm 3) Finally, if the step up in basis is eliminated, then the heir would get $600 million, with a $60 million basis, so if they sold the stock they would have a capital gain of $540 million, is that correct?
If and when the law is ever changed, I doubt it will work in the way that you describe.
Just for comparison, in 2010 they actually eliminated both the full step-up and the estate tax (but you were given a choice by tax filing time because they changed the law back again just in time). https://turbotax.intuit.com/tax-tips/es ... /L1AyZz1f8
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Lee_WSP
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Re: Step up in basis and estate tax

Post by Lee_WSP »

AlohaJoe wrote: Tue Oct 26, 2021 8:06 pm
Lee_WSP wrote: Tue Oct 26, 2021 5:03 pm That's correct, but there aren't that many billionaires.

The step up basis was due to the fact that the exemption used to be a million dollars and even less earlier. This snagged many middle class families, so the step up was introduced. No comment on the wisdom of the solution.
This isn't how the step up basis came into existence.

It has always been there, since the very beginning of The Revenue Act of 1916. It wasn't instituted later as a way to save struggling middle class families.

Indeed, you used to get a step up basis on gifts as well as bequests. That was eliminated in 1921 but the bequest step up basis doctrine remained.
The modern estate tax was also implemented that year. I'm not a historian, that's the explanation for why they structured it that way that I remember.

The estate tax has been around since the 19th century.

Edit: I did add the middle class part to bring some further modernity to the rationale, but indeed, it was a carve out.
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Lee_WSP
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Re: Step up in basis and estate tax

Post by Lee_WSP »

gobel wrote: Tue Oct 26, 2021 8:28 pm
MarkNYC wrote: Tue Oct 26, 2021 7:18 pm
solarcub wrote: Tue Oct 26, 2021 4:53 pm 3) Finally, if the step up in basis is eliminated, then the heir would get $600 million, with a $60 million basis, so if they sold the stock they would have a capital gain of $540 million, is that correct?
If and when the law is ever changed, I doubt it will work in the way that you describe.
Just for comparison, in 2010 they actually eliminated both the full step-up and the estate tax (but you were given a choice by tax filing time because they changed the law back again just in time). https://turbotax.intuit.com/tax-tips/es ... /L1AyZz1f8
The tax reform act of 76 instituted a carry over basis, but it was also retroactively repealed.

Canada purportedly has a carryover basis.
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