Bloomberg came out this morning with an article highlighting a Republican Congressional effort to draft a Contract with America Part 2. In this platform they plan to add Repealing the Estate Tax.
How could repealing the estate tax be bad for you? How could cutting any tax be worse for you?
Repealing the Estate Tax Repeals the Stepped Up Basis
In 2010, that one brief year without estate tax, average people learned how costly this could be. It was because of elimination of the stepped up basis on capital assets.
What does that mean?
Lets break it down. A capital asset is something you own. It doesn’t have to be something that goes up in value (businesses own many capital assets that depreciate). But for average people it usually means something that goes up in value.
Examples: your house; stocks; vacation home; collectible car.
Stepped Up Basis means that if your grandfather bought a house in 1960 for $25,000, and died in 2015. And left it to you in his will. And when he died the house was worth $750,000, you could sell that house the next day for $750,000 and pay NO TAX (in most circumstances).
The Reason? The “cost basis” steps up at death. So when you inherited it, the law treats it as if you just “bought” it for $750,000 and therefore have no taxable gain.
That’s pretty good isn’t it?
It sure is but this benefit mostly went away the last time they repealed the estate tax.
So what happened?
In 2010, those with very large estates paid no estate tax that year. Granted the estate tax rate is rather nasty. And some states like mine (Massachusetts), add a nasty state tax to the bill too (11% for estates
No estate tax will help some people!
over $1 million – note the level is different than the federal level).
Those with smaller estates, who would never have paid an estate tax, suddenly were potentially exposed to capital gains taxes on capital assets. In the example above, if there were no stepped up basis rule, that $725,000 gain on the house might be taxable if the house were sold. At 15-20% capital gain tax, that’s a big consequence of repealing the estate tax!
Here’s how Bankrate.com broke it down at the time:
In 2010 there would be a 1.3M exemption in stepped up basis. Plus 3M for spouses. So if a child inherited 2M of property, $700,000 would be over the exemption and taxable. In 2015 the rate hypothetically on the sale of a $2M inherited property would be 15-20%! As opposed to ZERO.
And now the middle class gets hit hard. In many cases in my work, the largest estate asset is the house. A middle class person passes away, and leaves their home to the kids to split. In many cases there is no tax.
But if the estate tax is repealed in the way it was before in 2010, there might be a tax. And that tax will hit many average families. the likely scenario would be a home or small business inheritance.
Repealing the Estate Tax – Just What the Government Wants
And to add insult to injury, perhaps government figures know this because reports show that repealing the estate tax will INCREASE government tax revenue.
And with recent decisions on Medicare and Social Security, the government is not opposed to dinging middle and upper middle income people.
For further reading:
Obama would love to increase taxes on the Middle Class by eliminating the step up basis: Wall Street Journal
Changes in Medicare costs: Medicare Hold Harmless – Chris Grande interviews Medicare expert Lindsay Quillen LCSW (Video).
Bipartisan Budget Bill Kills Popular Social Security Maximizing Strategy: Wall Street Journal
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