Step-up refers to the starting point for figuring capital gains when an heir sells assets such as stocks and bonds bequeathed to him or her. Under step-up, the capital gain is measured based on the asset's value at the time of the donor's death, not from when it was originally purchased. As a result, many years of capital gains go untaxed.
When it comes to making the wealthy pay more, "Hillary's proposals address some of the problems, but not the biggest one, which is non-realization of capital gains," Robert McIntyre, director of Citizens for Tax Justice, told Tax Analysts.
"Capital gains are not taxed until they are realized, typically by selling stocks or other assets. As a result, especially for the rich, most capital gains are never taxed. Instead, they are borrowed against or left to heirs, who get a stepped-up basis that forgives the tax forever," McIntyre said.
Consequently, McIntyre and others contend, wealth inequality continues to grow.
A January 2015 report from the Center for American Progress said, "Combined with the United States' generous estate tax structure, the step-up in basis rule creates very low effective tax rates on inherited wealth."
Conservative analysts, however, contend step-up is vital to prevent excess taxation of assets.
Big dollars are involved, regardless. The Congressional Budget Office estimated in 2014 that stepped-up basis would cost the Treasury $644 billion over the coming decade.
When President Obama proposed eliminating stepped-up basis as part of his fiscal 2015 budget, a White House fact sheet described it as the "trust fund loophole."
On January 12 Clinton decried a "private tax system" that benefits the rich and listed several preferences she wanted to end, but stepped-up basis was not among them. Her campaign did not respond to repeated questions about the issue.
Meanwhile, Clinton's main competitor for the Democratic nomination, Sen. Bernie Sanders, I-Vt., has placed step-up high on his target list.
"This exclusion in effect subsidizes wealthy families who hold onto assets in order to pass them onto the next generation, increasing the sort of dynastic wealth that is a feature of economic inequality," according to documents on Sanders's tax reform proposals made available to Tax Analysts.
Under Sanders's plan, the final personal income tax return filed on behalf of the deceased would include any previously untaxed capital gains, the documents say, adding that previously untaxed capital gains on assets given away would be on the donor's return for the years the gifts were made.
Sanders also includes provisions to protect from tax increases "the few low- and middle-income Americans who give away or pass on appreciated assets."
Harry Stein, fiscal analyst with the Center for American Progress Action Fund, said he remains hopeful Clinton will address the issue. "I suspect they may be mulling things over," Stein said. "It's one of those hidden subsidies [to the rich] that people don't really understand."
Steven Rosenthal of the Urban-Brookings Tax Policy Center also wants Clinton to put step-up on her to-do list. "Yes, I was disappointed, but maybe she -- or someone else -- will tackle [it] later," he said.
"There is a limited amount of revenue to be collected by raising tax rates on the highest income groups," said Rosenthal. "So, in my view, we need to broaden the tax base. Today, for the very wealthy, too much capital escapes taxation." He added that "taxing gains on death would capture more of it."
Potential Negative Consequences
But economist Curtis Dubay of the Heritage Foundation urges a go-slow approach regarding possible changes to stepped-up basis.
"Step-up is entirely appropriate when the death tax [or estate tax] is in place," Dubay told Tax Analysts. "It stops heirs from being taxed twice on assets -- once when the previous owner passed away and then again when they sell the asset. Since Clinton would keep the death tax, and increase it, it should stay," he said.
Dubay added, "If the death tax is repealed -- which is the right policy -- then it makes sense to switch from step-up to carryover basis. But only in that case." Carryover basis means the original cost for an asset transfers to the heir for measuring capital gains.
Stephen J. Entin of the Tax Foundation, in a January 2015 article, described step-up as being widely misunderstood. "The step-up in basis has been libeled as some form of tax 'loophole' for trust fund babies or the undeserving rich," he said, adding, "The step-up in basis is no loophole. The step-up is needed to prevent double or triple taxation of the same assets."
Obama's plan for ending step-up, Entin said, could have resulted in a 68 percent tax rate on capital gains upon death -- the 40 percent estate tax rate plus the proposed 28 percent tax rate on capital gains.
In short, Entin said, "ending step-up would be bad tax policy. It would surely harm capital formation and reduce wages and employment, and would ultimately lose revenue for the government."
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