Under the current tax code, most inherited assets receive a “step-up”¹ in basis to fair market value on the date of the decedent’s death.² President Biden’s proposal to repeal the step-up in basis³ could have an enormous impact on ultra-high-net-worth and high-net-worth investors if passed.

Understanding historical attempts to repeal the step-up in basis may help reduce client anxiety and assist advisors in successfully navigating the uncertainties of today’s tax environment.

Historical Attempts to Repeal Step-Up in Basis

Step-up in basis has been eliminated twice during the past 50 years, and each time, the change was short-lived.

Step-up in basis was first eliminated by the Tax Reform Act of 1976⁴ and replaced with a carryover basis regime. The carryover basis rules were heavily criticized and repealed a few years later, before they had taken effect.⁵

The Economic Growth and Tax Relief Reconciliation Act of 2001 repealed the estate tax and adopted a carryover basis regime for calendar year 2010 only.⁶ However, in December 2010, Congress retroactively reinstated the estate tax and step-up in basis rules for 2010 decedents.

2010 Fiasco

Although I do have a significant amount of grey hair (six kids plus many stressful tax seasons will do that to you), I was not practicing tax in the late 1970s. However, I did have a front row seat to the debacle that unfolded in 2010.

Cynics had a field day that year regarding the lack of an estate tax in place. Would relatives “pull the plug on granny” that year in order to avoid the estate tax? Would grandpa need a food taster at Thanksgiving to stay safe, if he made it that far?

It was reported that George Steinbrenner, the owner of the Yankees, went out “a winner” even in death, and his family “hit a home run” since his passing in 2010 purportedly saved his heirs hundreds of millions of dollars in estate tax.⁷ He certainly wasn’t the only billionaire who “hit the jackpot” that year.⁸

Many estate planners never expected 2010 to usher in a new year without an estate tax in place—they expected the law to change prior to 2010. Although Congressional efforts had been made to address the estate tax situation in the years leading up to 2010, they had all failed.

There was considerable uncertainty around the estate tax that year. Would Congress really allow billion-dollar estates to avoid paying a cent of estate tax that year, or would Congress retroactively change the law midyear?

Congress eventually threw everyone a curveball. In mid-December, Congress retroactively restored the estate tax and step-up in basis for 2010 decedents. However, for decedents who died in 2010, estate executors could opt out of the estate tax and into a carryover basis tax regime.⁹

I was working as a tax advisor in 2010, and three wealthy clients I served passed away that year. The estates of all three of these clients ended up opting out of the estate tax and into the carryover basis tax regime, giving me a taste of some of the challenges of a carryover basis regime.¹⁰

Reducing Client Anxiety

Given the impact of a repeal of step-up in basis on investors, it is understandable that many clients feel angst about such a proposal. The related Treasury “Green Book” proposal to also treat transfers of appreciated property by gift or on death as realization events likely heightens this apprehension. While these concerns are valid, educating clients on relevant considerations may help to ease this anxiety.

• Presidential tax proposals are not formal legislative bills and rarely become law in their original form.
• Due to a 50/50 split in the Senate,¹¹ every Democratic Senator has full veto power over the entire tax bill, and moderate Democrats may play an outsized role. Reaching a consensus amongst all Democratic senators on this proposal may not be easy.
• There have been prior presidential proposals to repeal the step-up in basis that were never passed into law, such as during President Obama’s administration.¹²
• There have also been prior proposals to treat transfers of appreciated property by gift or on death as taxable events that were never passed into law. For example, both the Fiscal Year 2016 and Fiscal Year 2017 “Green Books” proposed this change.¹³
• Step-up in basis has been eliminated twice before, and each time, the change proved transient.
• Even if passed, tax changes made this year could potentially be reversed the next time there is a shift in political power in Washington and may not be permanent.

Planning Considerations for Advisors

Will a third repeal of step-up in basis happen in 2021? If passed, will the change see its demise the next time there is a change in political power in DC, or will the third time be the charm? Only time will tell, but it is certainly possible that frequent tax regime change is here to stay.¹⁴

From a tax perspective, it’s likely that few predicted everything that happened in the years leading up to and during the late 1970s and 2010. During these periods of change and uncertainty, investors who stayed the course were likely rewarded for doing so. The same may be true today.

Accurately forecasting legislative changes to the tax landscape in 2021 and future years is difficult. Changing a client’s strategy based on political predictions can be risky, so maintaining flexibility and a long-term perspective is often the best course of action.

Other Tax Regime Blogs

• Impact of Green Book Capital Gains Proposals on Loss-Harvesting Strategies
• Tax Planning Under Election Uncertainty

Send questions or comments to blog@aperiogroup.com.

¹ Although commonly referred to as a “step-up” in basis, basis can also be “stepped down” to fair market value. This basis adjustment does not apply to assets considered income in respect of a decedent under Internal Revenue Code §691.

² Or alternate valuation date, if elected.

³ “The American Families Plan”; the Fiscal Year 2022 Treasury “Green Book” also proposes to make the transfer of appreciated property at death a gain-realization event.

⁴ Pub. L. No. 94-455, 90 Stat. 1520 (October 4, 1976), sec. 2005.

⁵ Crude Oil Windfall Profit Tax Act of 1980, Pub. L. No. 96-223, 94 Stat. 229 (April 2, 1980), sec. 401(a); “Tax Policy Center Briefing Book: Key Elements of the US Tax System,”; US Congress Joint Committee on Taxation, “Present Law and Background on the Taxation of High Income and High Wealth Taxpayers.”

⁶ Pub. L. No. 107-16, 115 Stat. 38 (June 7, 2001). On the campaign trail, President Bush had proposed eliminating the estate tax. The 2001 Tax Act endeavored to repeal the estate tax, but due to “budget reconciliation” rules, was limited to reducing the estate tax through 2009, repealing the estate tax in 2010, and then sunsetting after 2010. Under the “modified” carryover basis regime of 2010, the step-up in basis was limited to $1.3 million for assets passing to non-spouse beneficiaries. An additional $3 million of step-up was provided for assets passing to a surviving spouse.

⁷ “Steinbrenner Goes Out a Real Winner,” Forbes, July 10, 2010.

⁸ Hani Sarji, “Estate Tax Billionaires Would Have Owed,” Forbes, November 2, 2010.

⁹ The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, Pub. L. No. 111-312, 124 Stat. 3296 (December 17, 2010).

¹⁰ For example, one benefit of a step-up in basis regime is that you generally don’t have to worry about tracking down or computing the adjusted cost basis of assets. Since the basis of most assets is stepped up to fair market value after an estate event, the prior cost basis of an asset generally becomes irrelevant. However, in a carryover basis regime, an executor may be required to track down or compute the adjusted basis of assets that were passed through multiple generations or acquired many decades ago and for which detailed records do not exist. The person most likely to know this information may now be deceased. In some cases, this proved to be incredibly challenging in 2010. Even if death becomes a realization event as proposed in the Fiscal Year 2022 Treasury “Green Book,” the adjusted basis of an asset would still be required in order to compute the amount of the gain.

¹¹ There is a very slim majority in the House as well.

¹² “The President’s Plan to Help Middle-Class and Working Families Get Ahead,” April 2015.

¹³ Fiscal Year 2016 “Green Book”; Fiscal Year 2017 “Green Book.”

¹⁴ Patrick Geddes, “Tax Planning Under Election Uncertainty,” Aperio Group blog, September 29, 2020.

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