Tax Plan Targets Stepped-Up Basis

White House Tax Plan Targets Stepped-Up Basis, Section 1031 Exchanges

Chris Clayton
By  Chris Clayton , DTN Ag Policy Editor
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Farms passed on to heirs would be exempt from President Joe Biden's plans to cap stepped-up basis when heirs continue to run the family farm. They would more than likely face capital-gains taxes on increases in land value when they sell the farm, though. (DTN file photo)

OMAHA (DTN) -- While fears of farm groups were realized Wednesday as the White House rolled out its tax proposals under the American Families Plan, the White House maintains elimination of stepped-up basis would not apply to family-owned businesses and farms when heirs continue to run those farms and businesses.

President Joe Biden will talk in more detail about his administration's plans Wednesday night during the State of the Union speech.

Leading up to that speech, the White House formally released details on its American Families Plan, a $1.8 trillion mix of spending for education, childcare and expansion of the Affordable Care Act, as well as new anti-poverty measures.

Coupled with the plan are $1.5 trillion in tax increases targeting wealthier Americans, including increasing the top-line tax rate, doubling the tax on capital gains and eliminating the ability to avoid taxes on gains by passing assets on to heirs -- known as stepped-up basis.

A senior administration official who briefed reporters said the change in stepped-up basis includes provisions for family businesses such as farms. "This reform will be designed with explicit protections so that family-owned businesses and farms will not have to pay taxes when they give -- when given to heirs who continue to run those businesses," the official said.

Stepped-up basis for heirs allows a farm or ranch that may be a family holding for generations to pass down to heirs at the current market value. Farmland, for instance, bought generations ago at $100 an acre can pass on to heirs at the current market value -- $3,160 on average nationally. Heirs then who sell the ground do not have to pay taxes on the $3,060 increase in land values over time.

The White House official's brief comments implied heirs who continue to run a farm would not pay capital-gains taxes or be affected by the loss in stepped-up basis. However, those tax impacts would come into play when heirs sell the property tied to the inheritance.

The plan would raise the capital-gains tax rate from 20% to 39.6% for people who earn more than $1 million. When tacking on the Medicare surtax, the highest rate would go to 43.4% on capital gains. IRS data from 2018 returns shows this would only affect about one-third of 1% of American taxpayers -- .32% -- who have adjusted gross income of more than $1 million, as well as having capital gains or losses on their tax returns.

"This change will only apply to 3/10ths of 1% of American taxpayers," a White House senior adviser said.

The president's plan would set a $1 million exemption for assets to be passed on to heirs without paying the capital-gains tax -- $2.5 million exemption for a couple when current real-estate exemptions are added in. The White House said this cap on stepped-up basis "would eliminate the loophole that allows the wealthiest Americans to entirely escape tax on their wealth by passing it down to heirs." The goal of the plan is to tax billions in stocks that wealthy Americans hand down to heirs untaxed.

While few people in agriculture earn $1 million or more a year, farmers and livestock producers could find themselves caught in the capital-gains situation when they go to sell large equipment. But the higher capital-gains rate will hit farmers and ranchers more when they go to sell land or pass it down to their heirs.

When it comes to land values today, it takes less than 135 acres in Iowa to hit $1 million in value. With the average size of a farm in the state at 359 acres, that's topping $2.7 million in value.

In another tax change that could dramatically change real estate such as farm ground, the president's plan also would cap the value of deferred taxes on Section 1031 exchanges to $500,000. Current law allows taxpayers such as farmers to exchange real property such as land for a similar form of real estate.

An analysis earlier this month by the American Farm Bureau Federation and American Soybean Association noted the average value of farm ground has increased 223% since 1997. In some northern Midwest states, the value increases average more than 300%.

AFBF and ASA economists noted stepped-up basis "provides a reset for the asset value basis during intergenerational transfers." Heirs would be hit with higher taxes when they sold the land.

"Eliminating stepped-up basis to generate more federal income risks the livelihood of America's family farms and economic sustainability of these family operations long into the future."

An analysis by the Wharton School of Business at the University of Pennsylvania looking at the president's tax plans highlighted that increasing the capital-gains tax alone would not work without also coupling the tax hike with a cap on stepped-up basis. Adding the two moves together, however, would increase taxes $113 billion over 10 years.

The stepped-up basis issue was raised by senators Tuesday who spoke to members of the North American Agricultural Journalists (NAAJ).

Sen. John Boozman, R-Ark., ranking member of the Senate Agriculture Committee, pointed to the concerns about eliminating stepped-up basis for farmers as one of the risks farmers would face by Democrats using the budget reconciliation process to pass legislation. "For those of us who represent, or feel like we're representing agriculture, there are some poison pills," he said.

Discussing competing infrastructure plans, Boozman noted the Republican counteroffer to spend $568 billion was being rebuffed by Democrats for President Biden's proposal that would cost $2.2 trillion. Boozman said he sees Democrats looking for more ways to pass bills through the budget reconciliation process, which eliminates the need for a 60-senator vote of approval to clear a bill.

"I'm afraid we're going to have more reconciliation just because of the size and scope of these bills," Boozman said. "Again, there are significant tax increases."

Sen. John Hoeven, R-N.D., who is ranking member of the Senate Agriculture Appropriations Subcommittee and a member of the Agriculture Committee, said the stepped-up basis issue is "incredibly important, and farmers and ranchers and small businesses across the board really understand it." Hoeven said farmers and ranchers need to remain engaged about tax provisions. "Farmers and ranchers need to stay involved and talk about how important it is that they have the estate-tax credit and the stepped-up basis so they can transfer the farm or ranch, because it's not just the cost of your real estate in your land. Look at the incredible costs of the equipment," he said.

Hoeven added he raised that issue Tuesday when members of the Agriculture Committee met informally with Agriculture Secretary Tom Vilsack.

Sen. Tammy Baldwin, D-Wis., told reporters stepped-up basis was a topic Monday in a meeting she had with a Wisconsin farm group. Baldwin said she doesn't directly deal with tax issues but would be talking to members of the Senate Finance Committee about it.

Biden also plans to beef up IRS enforcement over the next decade with $80 billion more in spending with an emphasis on audits of higher-income taxpayers and corporations projected to pull in $700 billion more in taxes. The White House cited a study showing that 1% of Americans did not report as much as 20% of their income, leading to $175 billion in taxes that were not paid. The White House also noted budget cuts at the IRS had cut its audits by 80% on taxpayers making $1 million a year.

The White House stated, "The president's proposal would change the game by making sure the wealthiest Americans play by the same set of rules as all other Americans."

The American Families Plan comes on top of Biden's $2.3 trillion infrastructure package that has yet to move through Congress, effectively stacking up two massive legislative proposals that would cost nearly $4 trillion combined.

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Chris Clayton