- Democrats can’t decide whether to close a tax loophole that’s popular with the wealthiest Americans.
- The “step-up basis” loophole lets billionaires pass down investment gains without paying any taxes.
- Here’s how the loophole works, and why Democrats are split on whether to close it.
- See more stories on Insider’s business page.
Democrats face a looming deadline to pass an infrastructure package before the end of September – and they’re still squabbling over how to pay for it.
Many of the solutions are simple. House Democrats and the Biden administration both support higher taxes on rich Americans and corporations. But one particular tax issue – the “step-up basis” – sits at the center of their hemming and hawing.
It has to do with how, when Americans sell assets like stocks or bonds, they pay a capital gains tax on their earnings. If someone bought a stock for $US100 ($AU136) and sold it for $US250 ($AU341), they’d pay taxes on the $US150 ($AU204) profit.
Through the step-up loophole, however, those charges can be dodged entirely. If an investor transfers assets when they die, the inheritor receives them without a capital-gains tax burden. It’s also an easy way to dodge the estate tax. While estates are taxed when they’re transferred after the owner’s death, gifts – like unrealized gains from assets -aren’t.
Understanding the loophole of a ‘step up’ in value
The term “step-up” refers to the difference in value and tax liability that an asset has when it is acquired and when it is transferred to an inheritor.
The proverbial billionaire Jerry, for example, could buy a home for $US250 ($AU341),000 and sell it for $US1 ($AU1) million, after which he’d pay taxes on the $US750,000 ($AU1,021,658) gain. But if Jerry passes the home onto his daughter Ella, and she has it appraised at $US1 ($AU1) million, its value has taken a “step up” in value to $US1 ($AU1) million. If Ella sells the home for $US1 ($AU1) million or less, she wouldn’t owe anything in taxes.
For billionaires like Jeff Bezos and Elon Musk who earn far more through their investments than their salaries, this loophole is a perfect way to shield their wealth. Intergenerational wealth has contributed to surging inequality in America, which grew wider during the pandemic. Since 2019, the wealth of the top 400 richest people in the US increased by $US1 ($AU1).4 trillion, per research from Gabriel Zucman and Emmanuel Saez, a pair of left-leaning economists at the University of California, Berkeley.
“Often, for these people, wealth accumulates tax-free their entire lives,” Frank Clemente, executive director at the left-leaning advocacy group Americans for Tax Fairness, told Insider. President Joe Biden proposed ending this loophole and making billionaires “pay their fair share,” so why does it look like his party won’t touch it?
Democrats split on hitting the rich where it hurts
Biden wants inheritors to pay taxes on gains larger than $US1 ($AU1) million for single filers and $US2.5 ($AU3) million for couples. Coupling that with a higher capital gains tax rate could raise more than $US320 ($AU436) billion over the next decade, the White House said.
This week, the House Ways and Means Committee released tax proposals that would tax the rich more, including raising the top income tax rate to 39.6% and boosting the top capital gains tax rate to 25%. Left out of this framework, though, was an end to the step-up basis.
“The [Ways and Means] proposal fails to end the ability of the wealthiest filers to go through life without paying any taxes on the vast bulk of their incomes from assets, and this should be revisited as the reconciliation process continues,” Chye Chin Huang, executive director of the Tax Law Center at New York University, wrote on Twitter,
The Senate hasn’t released its own tax framework, but it is considering eliminating the loophole. “I feel very strongly that yearly, billionaires who did extraordinarily well in the pandemic should make tax payments like nurses or firefighters,” Sen. Ron Wyden of Oregon, chair of the Senate Finance Committee, told Insider.
Wyden will probably have to contend with moderates in the Senate, namely Joe Manchin and Kyrsten Sinema, just as moderates in the House have balked at closing the step-up loophole. If the moderates’ proposals prevail, the wealthy will likely continue to park their cash in assets with little financial consequence.
Closing step-up “is the one thing in the Biden plan that does get at wealth accumulation,” Clemente said. “For the really wealthy folks, they’re not going to have to cash out, so they won’t pay the tax anyway.”