How the stepped-up loophole creates an escalator to riches–for those who are already wealthy.

Last December, when Republicans passed their tax bill full of perks for their donors and corporations, another loophole dodged scrutiny and remained in the tax code. The stepped-up loophole, sometimes called the stepped-up basis loophole, is a huge advantage for families not quite rich enough to qualify for the estate tax (which has been raised to $10 million for an individual). Even estates which are large enough to pay estate taxes (0.2% of all estates) benefit from this anomaly.

Although estates with most of their assets in stocks need to pay securities to pay the estate tax, the estate income tax (the income tax on the estate before probate, distinct from the estate tax) on these sales (which occur after the date of death) uses this stepped-up basis. Whatever assets are left after the estate tax is paid are subject to the stepped-up basis. The loophole allows heirs to avoid paying capital gains taxes on inherited stocks and other assets. Here’s how:

Say you buy a stock for $1,000, and later sell it for $2,000. You have made a profit of $1,000, and that would be subject to taxes because it is a form of income. The amount of money that is subject to taxes is calculated by subtracting the “cost basis,” also known as the original cost of buying the stock, from the final sale price. $2,000- $1,000= $1,000. Simple.

In addition, the states take their cue from the federal government, and have taxpayers use this same, high basis for calculating state taxes. This is almost a fluke.

Because New York State, for example, begins its income tax calculation with the federal taxable income — there is no convenient way to close this loophole at the state level. The state does not have an independent calculation of the cost basis for assets. Couples also arrange their assets to take advantage of the rule that allows surviving spouses to take advantage of the stepped-up basis, even though they pay no estate tax at all.

What the stepped-up loophole does is consider whatever the current sale price is as the new cost basis when the stock transfers to your heirs following your death. The original price of the stock has stepped-up to the current amount it is worth. So, say your heir receives the stock when it is now worth $2,000 and immediately sells it. They would then pay no taxes at all.

It’s unclear why this loophole even exists, though it wouldn’t be unreasonable to suggest it is just another boondoggle to the rich. This loophole benefits the very wealthy– people who have assets who have accumulated gains over dozens and dozens of years, sometimes generations. Families who have so much wealth that they have not needed to sell off stocks or assets benefit the most from this loophole, and avoid paying their fair share in taxes to Washington.

Though politicians tout meritocracy as one of the country’s greatest ideals, the stepped-up loophole proves the opposite is true. This loophole protects generational wealth in a way that continues to disadvantage minorities and others who have been historically barred from economic gains achieved through capitalism. Rather than work to level the playing field, politicians who protect the stepped-up basis continue to undermine the free market and millions of Americans’ chances of breaking into the arena.

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