Deconstructing the Trust Fund Loophole

With some rhetorical license, the White House fact sheet describes IRC §1014 as the “trust fund loophole” and goes on to suggest that it may be “the largest single loophole in the entire individual income tax code.” Section 1014 provides that “the basis of property in the hands of a person acquiring the property from a decedent or to whom the property passed from a decedent … be the fair market value of the property at the date of the decedent’s death.” The basis of an appreciated asset is said to be “stepped-up” at death.
The fact sheet describes a situation where a person inherits stock worth $50 million. Working with that example, if at a mother’s death she passes that stock to her daughter, the daughter’s basis in the stock will be $50 million. Under current law, if the daughter immediately sells the stock no capital gains tax will be paid because the basis was stepped-up at the mother’s death. The fact sheet fails to point out that the estate of the mother would pay somewhere between $15.6 million and $20 million in federal estate tax at a 40 percent rate, depending on the availability of the deceased mother’s unified credit against estate tax available. And in any one of 19 states (and the District of Columbia), the mother’s estate would owe state estate tax as well. Under President Obama’s proposal, the mother’s death would not only trigger the payment of estate tax, but it would be a realization event giving rise to possible capital gains tax.

President targets inherited assets in middle class tax reform

After the American Taxpayer Relief Act of 2012 (ATRA-2012) (Pub L 112-240, 126 Stat 2313), many in the estate planning community thought that tax law dealing with estates and trusts was settled for some time. President Obama’s earlier budget proposals calling for a higher rate and a lower exemption (among other changes) and the Republican support for the repeal of the estate tax were seen by many as pro forma budgetary proposals. But on January 17, 2015, President Obama released his tax relief proposal for middle class families. Included in the plan are expanded child care, education, and retirement tax benefits and other tax credits to support working families. To pay for these provisions, the President proposes to:
Eliminate the “stepped-up” basis rules in the Internal Revenue Code, treating bequests and gifts as realization events subject to capital gains tax;
Increase top capital gains and dividend tax rates; and
Impose a fee on the liabilities of large U.S. financial firms.