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Obama Proposes Changes to Federal Tax Policy

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Jonathan Kinney and Lauren Keenan Rote
BKK Wills, Trusts and Estates Newsletter
February 2015

In his State of the Union Address on January 20, the President outlined changes he would like to see made to federal tax policy.  Among his proposed changes, President Obama suggested closing the stepped up basis "loophole" and increasing the top tax rate on capital gains and dividends from 23.8 percent to 28 percent. If such proposals become law, this could have major impacts on mid- and high-income Americans and their families.

Currently gifts made at death receive a favorable "step up in basis." The unrealized capital gains are not currently taxable. This means that when a person inherits appreciated property from a decedent, the value to the recipient is not the value of the decedent's basis (established when they first purchased or received the property) but rather is the higher, appreciated value of the property at the time it is inherited. This "stepped up basis" reduces the amount of capital gains taxes that are owed when the inherited property is later sold by the recipient.

The Capital Gains rate differs from the Federal Estate Tax, which currently applies to estates in excess of $5.43 million dollars (or $10.86M for married couples). Assets in excess of the Federal exemption are taxed at 40%. This tax is levied on the Decedent’s estate and is in addition to any capital gains taxes that may also be due by recipients of gifts.

The President's proposal would do away with the "stepped up basis" and increase the highest tax rate for capital gains to 28 percent. This increase, if enacted, would continue the recent trend in climbing rates. Two years ago the highest rate for capital gains was 15%. 

The President's plan would only exempt the first $200,000 in capital gains per couple plus $500,000 for a home, along with all personal property except for valuable art and collectibles. Anything else outside the exemption would be treated as income for tax purposes.

Obama hopes the changes will generate more revenue which can be used for programs benefiting lower-income and middle-class families, such as his recent proposal to provide seven (7) days of paid sick leave for all workers. 

This isn't the first time that elimination of the stepped up basis tax policy has been proposed. This “loophole” was closed twice before in the early 1970s, only to find that management of determining basis for property not receiving a "step up" at death was too onerous and costly, ultimately resulting in the IRS actually requesting that the policy change be reversed.  The President's plan is likely to face opposition from the Republican-controlled Congress. 

At this point, with a divided government, it's unlikely that this policy change will happen in the immediate future. If the political landscape should change in 2016, this issue could become front and center.

Jonathan Kinney is a shareholder of the firm practicing in the areas of estate planning and land use. He can be reached at jkinney@beankinney.com or 703.525.4000. Lauren Keenan Rote is an associate of the firm and practices in the areas of estate planning and administration and land use. She can be reached at 703.525.4000 or lrote@beankinney.com.