Important Considerations about the proposed American Families Plan

The Biden Administration’s American Families Plan includes a long list of initiatives aimed at expanding government support of children and families. It would cover much of the cost of these initiatives through a series of tax changes that include a major overhaul in the tax treatment of capital gains.

Long-term capital gains, the appreciation of an asset that the owner has held for more than a year, is taxed at a top federal tax rate of 20% when the asset is sold by the owner. In 2021, the 20% rate applies to single filers with taxable income over $445,850 and married taxpayers filing jointly with taxable income over $501,600. The rate is 15% for most taxpayers below these thresholds.

When you give long-term gain property to charity, you are allowed to deduct the current value of the property from taxable income, and you do not have to pay tax on the capital gain. This double tax savings provides a strong incentive to give highly appreciated assets, such as stock, to charities rather than cash.

The American Families Plan proposes a neardoubling of the tax rate on long-term capital gains from 20% to 39.6% for taxpayers with taxable income greater than $1 million. Thus, the tax benefits of giving long-term appreciated assets to charity will be greatly increased. Between income tax savings and avoiding capital gains tax and the 3.8% Medicare surtax, you could save over $0.80 in taxes for every $1 of long-term appreciated assets donated to charity rather than selling.

The American Families Plan proposes another change in the federal taxation of capital gains that would affect a far larger swath of individuals than those with incomes greater than $1 million: elimination of the step-up in cost basis for inherited gains over $1 million ($2.5 million per couple when combined with existing real estate exemptions).

At death, appreciated assets passed to heirs through the deceased’s estate receive a “step-up” in basis. This means that the cost basis of these assets in the hands of the heirs is reset to match their value on the date of the deceased’s death. If the heirs were to sell the assets that day, they would owe no capital gains tax, no matter how little the deceased paid for the assets originally. In addition, the current federal estate tax exemption of $11.7 million per individual ($23.4 million per couple) eliminates the estate tax for 99.9% of estates. The combination of the step-up in basis and very high federal estate tax exemption means that for 99.9% of estates, the appreciation in assets passed through estates is never taxed. It also means that for all but 0.1% of estates, there is no federal tax incentive to give appreciated property to charity through the estate.

If the American Families Plan becomes law and the federal estate tax exemption is reduced instead of 0.1% of estates facing federal taxation, closer to 10% would. Estates would pay a 39.6% capital gains tax on gains passing to heirs that exceed the applicable exemption amount – 43.4% when you include the 3.8% Medicare surtax. If the estate were large enough to also owe federal estate tax, federal estate tax would also apply. Capital gains tax would be deductible from the taxable estate, but the total of taxes paid on the gains could be more than 60%. Compare that to 40% today.