President Obama generated immediate controversy and backlash with one provision of his Middle Class Tax Fairness proposals, announced during the State of the Union address. That was the idea of taxing earnings in 529 plans, which proved so unpopular that the administration quickly dropped it.

It’s interesting that so far there hasn’t been much controversy around an even bigger idea in the same package – eliminating stepped-up basis on capital gains at death.

The president wants to replace stepped-up basis with: 1) a new personal exemption of $100,000 in capital gains at death, 2) no capital gains tax for married couples until the second death, 3) deferral of capital gains tax on family-owned and operated businesses (until sale), 4) a new option for closely held businesses to pay capital gains over 15 years after death, and 5) no tax on tangible personal property inheritances except “expensive art and similar collectibles.”

Stepped-up basis actually is pretty simple for folks to understand. All this is tax simplification?

The White House sees nothing good about stepped-up basis, calling it “perhaps the largest single loophole in the entire individual income tax code” and a huge boon to the wealthiest 1%, at the expense of the middle-class.

The White House also would increase the top capital gains rate from 23.8% now to 28%. Since, according to the White House, “each year, hundreds of billions in capital gains avoid tax as a result of stepped-up basis,” the proposal also would increase Treasury revenues, which no doubt is a motive.

Here’s perhaps the most questionable statement in the proposal: “By letting very wealthy investors make their capital gains disappear at death, stepped-up basis creates strong ‘lock-in’ incentives to hold assets for generations, even when resources could be reinvested more productively elsewhere. The proposal would sharply reduce these incentives, making it a pro-growth way to raise revenue.”

The main types of assets people hold long-term to receive stepped-up basis are: 1) U.S. stocks; and 2) U.S. real estate.

It’s not just the top 1% that owns them long-term, and you have to wonder what the repeal of stepped-up basis would do to hasten liquidation of these assets, with some proceeds shifting into “pro-growth” opportunities overseas or the underground economy. 

The repeal of stepped-up basis is not likely to pass. But it’s a good time to discuss the concept with your clients and get their reaction. Click here for the White House fact sheet: