Summary

Estate taxes might sound like a major concern, but the reality is that very few Americans actually pay them. However, a lesser-known but more widely applicable tax benefit — the step-up in basis for inherited assets — is under scrutiny and could be on the chopping block in future legislation. Understanding how this tax break works and who actually pays estate or gift taxes can help you better plan your financial future and ensure your heirs are well-prepared.

💰 Understanding the Step-Up in Basis

One of the biggest tax breaks beneficiaries receive is the step-up in basis, which resets the value of inherited assets at the time of the original owner’s death. This means that gains accumulated over the lifetime of the deceased are essentially erased for tax purposes. If a loved one bought a stock decades ago for a low price and left it to you in their will, the taxable value of that stock is reset to the price on the day they died, not what they originally paid. As a result, you’d only owe taxes on any increase in value after their death, not before. This break can apply to inherited homes, stocks, and other property, although some assets like retirement accounts and annuities are excluded. Because of this step-up, many Americans benefit from the current estate tax system without realizing it.

Takeaways:

• A step-up in basis reduces the capital gains tax heirs pay on inherited assets.

• The tax break is automatic and benefits far more people than estate taxes affect.

• There is currently no legislation eliminating the step-up in basis, but it has been proposed.

Key Terms

• Step-up in basis: A tax provision that resets the value of inherited assets to the market value at the time of the owner’s death.

• Capital gains tax: A tax on the profit made from the sale of an asset.

• Estate tax: A tax levied on the estate of a deceased person before the assets are transferred to heirs.

• Gift tax: A tax on money or property transferred to another person without receiving something of equal value in return.

🏛️ Who Pays Estate and Gift Taxes?

Despite fears about “death taxes,” the odds of actually owing federal estate taxes are very slim. For 2021, estates had to be worth more than $11.7 million to be subject to the tax. Fewer than 0.1% of Americans who died left estates that large. Gift taxes are similarly rare — you can give up to $15,000 annually per person without filing a return, and you don’t owe gift tax until you’ve given more than $11.7 million over your lifetime. That said, these exemption limits are temporary and set to revert to $5 million (adjusted for inflation) in 2026, with the Biden administration proposing an even lower limit of $3.5 million. Additionally, a dozen states and the District of Columbia have their own estate taxes with lower exemption thresholds, and six states also impose inheritance taxes. Depending on where you live and who your heirs are, local taxes could have more of an impact than federal ones.

Takeaways:

• Most estates aren’t large enough to trigger federal estate or gift taxes.

• State estate and inheritance taxes vary and may apply even when federal taxes don’t.

• Exemption thresholds are scheduled to drop after 2025, which could impact more estates.

Key Terms

• Federal estate tax exemption: The value threshold under which estates are not subject to federal estate taxes.

• Annual gift tax exclusion: The amount you can give per person each year without triggering the need to file a gift tax return.

• State inheritance tax: A tax some states impose on heirs, depending on their relationship to the deceased.

🗂️ What You Should Do Now

Even though changes to the step-up in basis haven’t been enacted, it’s smart to keep good records of your asset purchases and improvements. If new laws are passed in the future, having this documentation could be crucial. For instance, if you buy stocks or real estate, retain records of your purchase price and any enhancements made over time. This information can establish a higher cost basis, potentially lowering the capital gains tax your heirs would owe if the step-up is eliminated. Tracking your investment history is simply a good habit that can benefit both you and your loved ones when it comes to taxes and estate planning.

Takeaways:

• No immediate action is needed, but start organizing asset records now.

• Track purchase prices and home improvement costs to establish basis.

• Good record-keeping is a valuable part of any estate planning strategy.

Key Terms

• Asset basis: The original value of an asset used to determine capital gains or losses.

• Estate planning: The process of arranging for the management and distribution of your assets after death.

• Record-keeping: Maintaining documentation of asset values and improvements for tax and legal purposes.

Conclusion

Estate and gift taxes may not affect the average American, but the potential elimination of the step-up in basis could change how inheritances are taxed in the future. While no action is required just yet, keeping thorough records of your assets can help prepare you and your heirs for any eventual changes in the law. Understanding how current estate tax rules work — and who they impact — is a valuable part of smart financial and estate planning.