What is the “Angel of Death” Tax Loophole?
The “Angel of Death” tax loophole is also known as the “Step-Up in Basis at Death” loophole. The concept is in the news because President Biden wants to eliminate it. This isn’t the first time a president has tried to eliminate this loophole. President John F. Kennedy asked Congress to repeal the loophole over 50 years ago – but Congress did not. It remains one of the - if not the - largest capital gains loopholes in the U.S. Tax Code. Here is an example to explain how it works.
Example
I’ll use shares of stock, but it applies to other assets including real estate. Let’s say that your mom purchased $5,000 worth of Microsoft stock in 1986. Those shares of stock are now worth $2,000,000. If mom sells her shares today, she would pay capital gains tax on $1,995,000 (the difference between what she paid for it and what it is currently worth). If we multiply $1,995,000 by the capital gains rate of 20% - mom would be paying $399,000 in taxes.
But…
What if instead of selling her stock, mom passes away and leaves those shares of stock to you? The Angel of Death loophole says that you inherit that stock with a stepped-up basis (normally the fair market value on the date of death). In our example, you would receive that stock as if you purchased it for $2 million rather than $5,000. And, if you sell it, you pay no capital gains tax!
So, it is pretty clear why the federal government would like to eliminate this tax loophole. It is estimated that by eliminating this loophole, it would raise more than $100 billion dollars over the next 10 years.
In addition to eliminating the Step-Up in Basis at Death tax loophole, there is also discussion about increasing the capital gains tax – possibly as high as 43.4%, which would dramatically increase the government’s tax revenue.
Is this proposed change a good idea or a bad idea? The answer to that question really depends on your particular philosophy.
I want to point out that these proposed changes do not just impact the very wealthy. As I mentioned above, this loophole applies to capital gains on many assets including personal homes. We frequently see families benefit from this when their loved one’s home is sold after they pass away.
Additional planning questions?
The impact of the Angel of Death loophole is, of course, only one of the many topics of estate planning. What if one of my children predeceases me? How do I protect my child with special needs? How does a power of attorney protect me and my spouse? What if I do not want extraordinary measures at the end of life? These are typical discussions I have with my clients.
A well thought out plan prevents conflict or the need for court intervention. If you would like to talk with me about creating an estate plan that allows you to choose the person you trust to make medical decisions and financial decisions for you in the event of your incapacity and ultimately how to pass on your wealth and legacy, please give me a call, send me an e-mail or schedule an appointment.