As tax policies face potential shifts, families must prepare for changes that could significantly impact how wealth is transferred across generations. Three major proposals—the elimination of the step-up in basis at death, the increase in the federal capital gains tax rate to 33%, and the reduction of the unified credit—could combine to severely impair family wealth. These changes would dramatically alter the landscape of estate planning, leaving families with greater tax burdens and fewer assets to pass on to future generations.

The Step-Up in Basis: Why It Matters

The step-up in basis is a crucial tax provision that adjusts the value of an inherited asset to its fair market value at the time of the original owner’s death. This adjustment is essential in minimizing capital gains taxes when the inheritor decides to sell the asset. Without the step-up, heirs would owe capital gains taxes on the difference between the original purchase price and the asset’s value at the time of inheritance, which could be substantial for long-held assets like real estate or investments.

For example, if a family inherits a property originally purchased for $200,000 and now worth $1 million, the step-up in basis would reset the value to $1 million, allowing the heirs to avoid capital gains taxes on the $800,000 appreciation. The elimination of this provision would force heirs to pay capital gains taxes on that $800,000 gain, significantly reducing the amount of wealth transferred.

A Higher Capital Gains Tax Rate: Impact on Inherited Wealth

Increasing the federal capital gains tax rate to 33% would further amplify the financial burden. Currently, long-term capital gains are taxed at a maximum rate of 20%, with an additional 3.8% Medicare surtax for high-income earners. A rise to 33% would increase the total tax liability on inherited assets, further reducing the wealth passed on to future generations.

For instance, using the earlier example of a $1 million inherited property, without the step-up in basis, the $800,000 capital gain would now be taxed at 33%, resulting in a $264,000 tax liability—money that would otherwise have been preserved for future generations.

The Unified Credit: Shrinking the Estate Tax Shield

The unified credit allows individuals to transfer a set amount of wealth tax-free during their lifetime or at death. In 2024, this exemption stands at approximately $12.92 million for individuals and $25.84 million for married couples. However, proposed changes aim to reduce this threshold, meaning more estates would be subject to federal estate taxes.

A reduced unified credit would expose even moderate-sized estates to substantial estate tax liabilities, further compounding the financial strain caused by the elimination of the step-up in basis and the increase in capital gains taxes. Families would need to prepare for estate taxes on a larger portion of their wealth, potentially forcing them to sell off assets like family businesses or real estate to cover the tax bills.

The Combined Impact: A Perfect Storm for Family Wealth

Together, these three tax changes could create a perfect storm for families looking to transfer wealth across generations. The combined effects would be devastating:

  1. Double Taxation on Inherited Assets: The elimination of the step-up in basis would subject heirs to significant capital gains taxes, while the reduction in the unified credit would expose more estates to estate taxes, effectively resulting in double taxation.
  2. Forced Asset Sales: To cover the increased tax liabilities, families may be forced to sell assets, often at a loss or under less favorable market conditions. This is particularly concerning for those with illiquid assets like family-owned businesses or real estate, which could be sold to cover tax bills rather than preserved as part of the family legacy.
  3. Erosion of Generational Wealth: Families have historically relied on the step-up in basis and the unified credit to preserve wealth across generations. Without these provisions, the amount of wealth passed down would be significantly reduced, limiting opportunities for future generations to build upon that legacy.

Strategies to Mitigate the Impact

While these proposed changes pose serious challenges, families can take proactive steps to protect their wealth:

  • Gifting During Lifetime: Consider gifting assets while still living to reduce the size of the taxable estate and take advantage of the current unified credit before it is potentially reduced.
  • Trusts and Estate Planning Tools: Trusts and other sophisticated estate planning vehicles can help shield assets from both capital gains and estate taxes, offering more control over wealth distribution.
  • Diversifying Investments: Invest in assets that are more tax-efficient or less subject to capital gains taxes to minimize exposure in the event of policy changes.
  • Engage in Early Planning: With these changes on the horizon, early and ongoing planning with financial advisors and estate planning attorneys is crucial to minimizing the impact on family wealth.

Conclusion

The proposed elimination of the step-up in basis at death, the increase in the capital gains tax rate to 33%, and the reduction in the unified credit represent a significant threat to generational wealth. The combination of these changes would drastically increase tax liabilities, erode family assets, and undermine the ability to pass on a financial legacy.

Now, more than ever, it’s essential for families to engage in proactive estate planning and explore strategies that can mitigate the effects of these tax changes. With the right approach, families can protect their wealth, ensure financial security, and preserve their legacy for generations to come.