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U.S. Senator Chris Van Hollen (D-MD) has introduced the Sensible Taxation and Equity Promotion (STEP) Act, which would result in the realization of capital gains on the date when property is transferred by gift, trust or death. This would end the current “step-up” treatment of inherited assets, and would be in addition to the existing estate tax. Similar legislation was introduced by U.S. Rep. Bill Pascrell (D-NJ), the chairman of House Ways and Means Subcommittee on Oversight. Both bills were introduced on March 29 and allow heirs to exclude up to $1 million in gain resulting from transfers at death.
Since 1921, no capital gains tax has been imposed when assets are transferred at death to an heir. Furthermore, tax law allows heirs to increase their basis in the bequeathed assets to fair market value without paying capital gains tax. This is referred to as a step-up of basis.
Taxing gains at death on top of taxing an estate can create a very high tax burden. For example, with a potential estate tax rate of 40% and capital gains tax rate of 20%, this double taxation of gains could result in a 52% tax rate, assuming that the capital gains tax is deductible from the estate tax. That is, for every $100 of gain the heir would only receive $48 and remit the other $52 in tax.
Repeal of step-up in basis would make death a taxable event even for families below the current estate tax exemption threshold ($11.7 million in 2021) — significantly broadening the scope of the United States’ death and inheritance taxes.
This high tax burden can be especially problematic when the primary asset in the estate is a business, as there may be little cash available with which to pay estate and capital gains taxes. The Pascrell bill would tallow taxpayers with illiquid assets, like a business or farm, to pay the tax in installments over seven years. Sen. Van Hollen’s proposal provides 15 years to pay the tax.