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Joe Biden's tax plan could hit middle- and lower- income Americans hard

Biden has been advocating that we get rid of the “stepped up basis on death” that has long been a part of American tax law. Such a move could hit middle-, and even lower-, income Americans hard.

John Aravosis

Mar 26

For a while now, Joe Biden has been advocating that we get rid of the “stepped up basis on death” that has long been a part of American tax law. Such a move could hit middle-, and even lower-, income Americans hard. Here’s why.

The stepped up basis on death applies to property you inherit. That could be stocks (outside of retirement accounts). Or it could be your family home or apartment. What the stepped up basis does is protect you from having to pay capital gains taxes on the property you inherit. (Note, I’m talking about capital gains taxes, not inheritance taxes.)

Let me give two examples.

Stocks

You buy $5,000 of Apple stock in 2010. The stock value reaches $20,000 in 2021, and you’ve therefore made a $15,000 profit, or capital gain, on your $5,000 investment. You then have to figure out what federal and state capital gain taxes you owe on the $15,000 profit. Since this is a long-term capital gain, i.e., held for more than one year, the federal capital gains tax is either 15% or 20%, depending on your overall income. The state tax is very often your state income tax rate — in DC that’s anywhere from 4% to nearly 9%. (It also should be noted that if you make under $40,000 per year, your federal capital gains rate is zero, UP UNTIL the profit from the stock pushes your income over $40,000, then you pay capital gains tax on anything over $40,000.)

So, if this were me, a DC resident, I might owe as much as a 29% tax on the inherited stock, or $4,350.

Complicated, no?

But if you inherit the stock — say your mom gives it to you on her death, you won’t owe any capital gains at all, federal or state, so long as you sell the stock immediately. Why? Because of the stepped up basis on death.

What the law says is that when you inherit property, the capital gains on that property — the profit, as it were — is reset to zero. So the IRS considers the $20,000 of inherited stock as if you just bought it, and you so far have no profit on it at all. So you owe no federal or state capital gains tax unless and until the stock rises and there’s some new profit, or capital gain, on the stock. Any new profit, or gain, over the $20,000 basis, as it’s called, will be taxed.

President Biden wants to get rid of this inheritance rule, and simply tax all inheritance property at the time of death of the person making the gift.

Homes

The same thing applies to homes. Your parents buy a home for $75,000 in 1970. Your parents die in 2021. The home is now worth $600,000, and you inherit it, per your parents’ will. Under existing law, even though the capital gain (the profit) on the home is $525,000*, you will pay no capital gains taxes if you sell the home immediately, because the IRS consider the gain/profit wiped out at the time of your last parents’ death, and reset to the current value of the home, $600,000.

Capital Gains tax burden: Zero.

(*As always, it’s a bit more complicated than this, even, because if your parents owned the home jointly, and one preceded the other in death, the stepped up basis rule would wipe out the one parents gain when the other parent inherited the property, leaving only the second parent’s gain. So the total capital gain on the property at the last parent’s death would be less than $525,000. Nonetheless, the remaining gain won’t be taxed under current law at all because of the stepped up basis rule.)

Under what Biden is proposing, your parents’ home will be immediately hit with a 20% capital gains tax, and state income tax, on their death. (And maybe even the ACA and Medicare taxes too.) In DC, that means, again, 20% plus nearly 9%, or a 29% tax on a home that you otherwise were going to receive tax free — or $152,250 in taxes. (And again, there may be additional ACA and Medicare taxes as well.)

That’s zero in taxes under current law, versus over $150,000 under Biden’s proposal. That’s a lot of money.

Even middle- and lower- income Americans could be affected

I’ve befriended a woman down the block from me in DC. She’s 60, living on disability because of her illnesses, and has a hard time finding the money to even pay for her prescriptions. I once mentioned to her that she could consider a reverse mortgage, as she surely has a lot of equity locked up in the house. She said no way, this house has been in her family for generations, she could never give it up, even after death — she wants her family to inherit the family home and live there for generations.

Under Biden’s plan, it’s hard to see how that would be possible. Let’s assume her parents or grandparents paid $75,000 for the house (and I suspect they paid even less, as DC wasn’t expensive at all back then). According to Zillow, her home is now worth $720,000. That’s a $645,000 profit, or capital gain. Normally, her heirs would pay no capital gains tax when they inherit the house. Under Biden’s plan, they would be hit with a 29% tax, costing them $187,050. (As always, it’s more complicated than this, but you get the idea — the tax isn’t insignificant.)

That’s a heck of a lot of money to a middle- or lower-income family.

But it’s worse than that. Biden has said he wants the tax owed on the death of the owner. That means, her family — or her estate — will owe $187,050 the moment she dies. Where are they going to get that kind of money? They’re going to sell the house, of course. The house that she so wanted to keep in her family, she refused to use it buy the drugs she needs to stay alive.

Lower- and Middle- income Americans do own stocks and homes

A third of Americans own stocks outside of retirement plans. The breakdown, according to PEW, shows that 14% of lower-income Americans own stocks, bonds, or mutual funds outside of an investment account, while 38% of middle-income Americans own the same. These are the people who could now owe inheritance taxes under Biden’s plan. Yes, the rich are an even greater number, but lower- and middle- income is hardly insignificant.

As for homes, nearly 66% of Americans own one. By race: 73% of white non-hispanic Americans own a home; 47.5% of Latinos; and 42.1% of Blacks. Again, that’s not a small number of people being impacted by this change in the tax law.

As for how this applies to income, according to the Urban Institute, some low-income Americans do in fact own homes — far more whites than Blacks, however — but still, nearly 1/4 of Blacks earning less than $25,000 own a home, and a bit more than 1/3 earning between $25,000 and $50,000 own a home. Again, that’s not an insignificant number.

The Republicans have been irresponsible with the deficit for decades. Every time a Republican is elected president, the deficit soars. A Democrat then comes in and tries to fix things. But it is patently unfair to propose something that is a huge tax on middle- and lower- class Americans.

We live in a country where the pensions of our fathers and grandfathers no longer exist. For most of us, retirement is going to be what’s left of Social Security, our paltry retirement plans, and anything we get from our parents. It’s going to be hard enough making ends meet in retirement, let alone losing the help many of us were going to get from our parents.

Say it ain’t so, Joe.

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