Democrats struggle with plan to tax dynastic wealth

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While they’d be a small share of those affected, those people represent an outsized political problem for Democrats.

“They’re fine catching really high-income people, but they don’t want to catch my Aunt Jo,” says Rick Grafmeyer, a former top tax aide in Congress now at the firm Capitol Tax Partners.

It’s an example of how Democrats will face a whole new set of challenges even if they end negotiations with Republicans and go it alone with their plans for another big-spending package.

Democrats want to fund a big chunk of their spending package by curbing the nearly century-old provision, sometimes called the Angel of Death loophole and technically known by the clunky term “stepped up basis at death.” Along with a related plan to raise capital gains rates on millionaires, it is projected to raise more than $300 billion over 10 years.

But the idea is running into intense opposition, with even some Democrats uncomfortable with the proposal. Last week, House Agriculture Chair David Scott (D-Ga.) called the administration’s plan “untenable.”

At issue is a plan to require a lot more people to pay taxes when they die — something only the very wealthy currently have to worry about.

They’re subject to the estate tax, which is a levy on the transfer of wealth to their heirs. Republicans have been loosening the tax for years, which now only kicks in once a single filer has more than $11.7 million in assets. Just a couple thousand taxpayers typically pay it each year.

Democrats are not proposing to tinker with the estate tax, but their bid to end the capital gains exemption would amount to creating a new tax due at death.

Here’s how it would work: Normally, when someone sells an asset, like a stock, they have to pay the capital gains tax on any growth in its value. So if someone sells a stock for $100, and it originally cost them $25, they pay tax on the $75 difference.

But a different set of rules apply when someone dies: the starting point for calculating the tax — known as the “basis” — is increased, or stepped up, to current values. So the heir receiving the stock originally purchased at $25 would only owe taxes on any appreciation beyond its current $100 value.

The provision has been part of the tax code for nearly a century though it is widely considered unfair by tax experts, in part because it can allow the wealthy to escape taxes on huge fortunes.

For instance, if Jeff Bezos were to sell all of his Amazon stock while he is alive, he’d owe taxes on all the appreciation since the founding of the company. But if he simply waits until he dies, that tax would evaporate, even if his heirs sell the stock the next day.

“It’s a loophole for the American aristocracy,” said Sen. Chris Van Hollen (D-Md.).

Now, the Biden administration wants to require people to pay taxes on the appreciation of unsold assets when they die.

To avoid hitting average Americans, it would give people a $1 million-per-person exemption, along with a $250,000 per-person housing allowance. Couples would get twice that.

The Treasury Department says fewer than a half-percent of taxpayers would be subject to the tax — a tiny share overall, though still be a big increase compared to the number now subject to the estate tax.

In some ways, it would be a throwback to the 1970s, before Republicans began relaxing the estate tax. In 1976, when the estate tax kicked in when people had assets worth more than $60,000, almost 8 percent of everyone who died paid it. By comparison, fewer than 0.1 percent of decedents today pay the estate tax.

Advocates of Biden’s plan got a boost Tuesday when ProPublica reported that Bezos, Tesla Founder Elon Musk and others at the pinnacle of the earnings ladder have paid little or no income taxes even as the value of their unrealized capital gains soared.

To shield itself politically, the administration is proposing special rules for two of the most politically important groups that would be affected by its plan: farmers and small businesses.

Farmers worry about having to pay tax on land that’s been appreciating for decades while small business owners are concerned about being able to hand down their companies to children.

While farms and small businesses would lose the step-up treatment, the administration is proposing to allow them to postpone paying the resulting tax until their business or farm is sold or ceases to be family-owned and operated.

What’s more, they’d then get 15 years to pay off the bill. (Details like which family members would count would be worked out by Congress).

But the influential American Farm Bureau Federation is rejecting the administration’s attempt at compromise — which will put Democrats from rural areas in a tough spot. The National Federation of Independent Business, another group with clout, is similarly opposed.

“No exemption or carve out is better than current law,” says Courtney Titus Brooks, NFIB’s senior manager of federal government relations. Small business owners “would still have a tremendous tax liability hanging over them.”

Those aren’t the only politically sensitive groups that could be hit by the plan.

It could also affect people who are well-to-do but not extremely wealthy. Think of someone who has owned a home for 30 years in a high-cost city like Washington, D.C. If they also have a vacation home and a stock portfolio swelled by the recent runup on Wall Street, they could find themselves on hook for the tax.

“This isn’t just affecting the Jeff Bezos’s of the world or the folks in the Hamptons or the people in Malibu,” said Kenneth Van Leeuwen, who runs Van Leeuwen & Company, a financial planning firm in Princeton, New Jersey.

There would also be a small number of people with incomes below $400,000 who would be subject to the tax — even though the administration has said it won’t raise taxes on people making less than that — because they are sitting on a pile of unrealized capital gains.

It could be someone who never earned more than, say, $80,000 during their working lives, but who purchased shares in their companies through employee stock option programs that have been growing in value for decades. The Tax Policy Center figures 2 percent of decedents who made less than $400,000 could be liable for the tax.

“It seems inevitable that some people with incomes under $400,000 are going to be affected,” said Robert McClelland, a senior fellow with the group.

Speaking on condition of anonymity, a Treasury official said that would not violate the administration’s pledge because if someone had enough unrealized gains at the time of their death to owe the tax, then that person, by definition, would have made more than $400,000.

Jonathan Blattmachr, a longtime estate tax lawyer who supports Democrats’ plans, says its critics are focusing on the wrong people.

While the tax would technically be paid by the person who died, in reality, he says, it would be borne by their heirs — because they’re the ones who are still alive.

“The person who bought the Tesla stock is never going to pay the tax if he doesn’t sell it during his lifetime — you’re not hurting him,” he said. “It’s the heirs who will pay.”

And he would not feel badly for them.

They are merely “the lucky winners of the sperm lottery — who were born into a wealthy family who will inherit a tremendous amount of money for nothing they did.”

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