On January 20^th, 2015, President Obama stood before a joint session of Congress and delivered the annual State of the Union address. Some of the topics discussed were the current State of the Union, College Savings Plan reform, his legislative agenda as well as several White House proposed tax reforms for the upcoming fiscal year.

While many of his new policies will affect all Americans in some way, several of his proposed tax increases will particularly affect upper-income persons and financial corporations. One in particular is a proposed change to the tax on appreciated estate property, otherwise referred to as the “trust-fund loophole.”

Taxation on Appreciated Estate Property

The term Capital Gain stands for the profit realized on the sale of a non-inventory asset that was purchased at a cost amount that was lower than the amount realized on the sale.  In the United States, individuals and corporations pay U.S. federal income tax on the net total of all their capital gains just as they do on other sorts of income. “Long term” capital gains are generally taxed at a preferential rate in comparison to ordinary income.

Currently, the law states that property which has appreciated in value that is owned by an estate is generally not subject to tax at death. Under this tax scheme, children and other heirs typically receive and sell property with little or no capital gains tax since most property receives an increase in basis to fair market value. For example, a parent who dies can pass along a valuable asset to their child or heir with no capital gains tax being due. When the child or heir eventually sells the asset, the current law limits the eventual tax bill by figuring the taxable gain only since the parent’s death. While this is a feature commonly known as a stepped-up basis the administration refers to this as the “trust fund loophole” and is looking to change it.

The White House proposal is to tax this appreciated estate property. The proposal states that the tax will be at 28% if the difference between the cost of the property and the fair market value at death exceeds $100,000 per person. There would be a separate exclusion for a personal residence of $250,000 per person. The proposal would not include clothes, furniture and most other personal items.

In arguing its case for revising this aspect of the tax code, the White House claims that all of the gain on valuable property or assets that occur prior to the death of a parent unfairly escapes tax. The White House claims it is in good company. Critics of the current tax code say that it is outdated. They claim that while the current policy reduces disputes over prices paid for assets long ago, they acknowledge that revision to the tax code would unlock capital by removing an incentive for holding valuable assets for generations.

Many experts, such as USC tax expert Edward Kleinbard, agree. Mr. Kleinbard notes that the capital gains tax is our only truly voluntary tax. Taxpayers can defer it for a considerable amount of time simply by withholding on the sale of their taxable assets. He argues that if you’re rich enough to hang onto your stocks and bonds, or can utilize financial strategies to enable you to exploit their value without selling them, you can defer paying capital gains tax your entire life.

Whether the White House prevails in passing this legislation remains to be seen. It seems clear, however, that negotiations on tax policy will continue in attempts by the current administration to eliminate tax loop-holes. Eliminating the lock-in effect, where holders of appreciated assets avoid selling because of the taxes imposed on the sale, could have a major impact on estate planning strategies and should prompt concerned individuals to look more closely at their estate plans, which should be revised periodically to ensure the best treatment of ones assets.

These are issues that make estate planning a complex field. Whether you are concerned with devising a plan for either a family estate or that of a business, it is important to get good advice. The attorneys at Lonich Patton Erlich Policastri have decades of experience handling complex estate planning matters including business succession plans, wills, and living trusts. If you are interested in developing an estate plan or reviewing your current estate plan, contact the experienced estate planning attorneys at Lonich Patton Erlich Policastri for further information as we are happy to offer you a free consultation.

Please remember that each individual situation is unique and results discussed in this post are not a guarantee of future results.  While this post may detail general legal issues, it is not legal advice.  Use of this site does not create an attorney-client relationship.