ALBUQUERQUE, N.M. — President Joe Biden has proposed tax increases on corporations and high-income individuals.
He reminded us that he would keep his campaign promise to protect the middle class from tax harm.
One proposal is to raise the top capital gains rate for very high-income individuals. This may be limited to those with taxable income above $1 million for the year.
Experience shows that measuring the impact of changing the rate on capital gains can be challenging. Let’s say that in December of 2021, the tea leaves suggest a high probability that capital gain rates will rise in 2022.
Affected taxpayers will tend to realize capital gains in 2021 to avoid the expected rate increase. This may leave fewer gains to be taxed in 2022.
The short-term impact will be a spike in capital gains tax collections in 2021 and perhaps a cratering in 2022 collections. High collections in 2021 and low in 2022 will seem to support the argument that raising capital gains tax rates will lower revenues.
Continued comparisons may support a different story – investors affected by the proposed change acted one time to accelerate gains. This behavior cannot continue forever as the rate will not continue to increase.
The Biden administration seems to understand that the real money may be in the tax basis of the assets sold. This tax basis is used to determine the amount of the taxable gain when the asset is sold.
Under current law, when property is inherited the heir is allowed to adjust the tax basis of the property to its fair market value (FMV) on the date of the decedent’s death. This allows the heirs to escape any tax liability for gains realized during the decedent’s lifetime.
The president has proposed eliminating this tax basis adjustment for inherited property. It seems this will apply only to the “high income” people.
Defining high income for this purpose is a bit more challenging than for annual income tax purposes. It seems that the definition will instead focus on the decedent’s wealth at death. The heir may be quite the ordinary Joe.
I have some experience with ordinary people. I come from them. My grandmother dropped out of school after the 8th grade to help support her family as a seamstress, and later working in a rug mill.
My grandfather left school after 6th grade and worked playing piano for silent movies, singing in a saloon, playing semi-pro baseball, and also working at the rug mill.
My grandmother said she owned “half a house” – joined with another with the same floor plan and sharing a porch. Grannie said she and Pop paid $7,000 for the house. Or maybe $4,000. Or perhaps $8,000. Depends on when she told the story.
She couldn’t remember a real estate transaction from 50 years earlier. She attached people’s names to her furnishings. This told who would get the property following her demise. However, the slips of paper did not say what the stuff cost her.
It’s hard to remember what you paid for things. Even corporate stocks and mutual funds are bought at many times and at many prices. The IRS allows average cost to be used because we just can’t keep records of every purchase.
My grandparents had 14 years of schooling between them. I have more than that in earning three college degrees. Many families have a similar pattern as generations move on. My Grannie wanted us to have education to have a better life than her.
If high wealth means $1 million of assets at death, Grannie fell about $910,000 short, dying with just half a house. Her grandchildren will do better, even if they are not rich.
The Biden proposal to eliminate a basis adjustment at death will affect many people, perhaps heirs of anyone with $1 million or more of assets at death. Not just the 1%.
The heirs will have no idea what was paid for most assets inherited. Even the people who bought the assets didn’t know.
The basis adjustment rule is not just a tax giveaway. It solves the problem of the heir who has no idea what the decedent’s original cost was. For ordinary people that can be simple tax relief.
Jim Hamill is the director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at firstname.lastname@example.org.