Klenk Law

What’s the “Angel of Death” Tax Loophole and Why Should You Care?

Posted on Thu Jan 22, 2015, on Estate Planning

President Obama’s 2015 State of the Union Address was a throwback in some aspects. Specifically, Obama’s proposal included removing a veteran staple in the estate planning attorney’s playbook, the so-called “Angel of Death” tax loophole. Let’s take a look at exactly what the “Angel of Death” tax loophole is, and why you should care about it.

What is the Angel of Death tax loophole?

Even though President John F. Kennedy asked Congress to repeal the loophole 52 years ago, it remains perhaps the largest capital gains loopholes in the US Tax Code. The Angel of Death tax loophole allows individuals to inherit appreciated capital gains assets with a step-up in basis. A simple example will make the loophole clear.

Let’s imagine your father (the smart man he is) bought $10,000 worth of Apple stock in 1990. If he sold that today, it would be worth approximately $1,200,000 and he would have to pay capital gains tax on $1,190,000. Multiply that by the highest marginal capital gains rate of 23.8% and that equals a tax payment of $238,220.

What if there was a way to avoid that tax? That is precisely what the Angel of Death loophole does. If, instead of selling the stock, your father bequeaths it to you, the stock would be inherited by you with a stepped-up basis (usually the fair market value on the date of his death) and the increase of value from $10,000 to $1.2 million are gone — never subject to capital gains tax!!

You can understand why the U.S. Treasury estimates this loophole costs the US $50 billion per year in revenue. With the baby boomers set to begin the largest generational wealth transfer in history, closing the loophole is an increasingly attractive source of revenue. Coupling that with the proposed increase in the highest marginal capital gains tax rate from 23.8% to 28% would make it even more attractive.

Why should you care?

Simply put, in our one example, your father dying today versus after the proposed changes would account for $333,200 less to your family upon his death. Further, the capital gains tax applies to other assets besides stocks which can include real estate, appreciated property such as cars, certain business interests, etc.

Father Sells Now

Fair Market Value ($1,200,000) – Basis ($10,000) = Taxable Gain ($1,190,000)
Taxable Gain ($1,190,000) x Current Taxable Rate (23.8%) = Tax Owed ($238,220)
Taxable Gain ($1,190,000) x Proposed Taxable Rate (28%) = Tax Owed ($333,200)

Father Dies with “Angel of Death” Loophole

Fair Market Value ($1,200,000) – Stepped Up Basis ($1,200,000) = Taxable Gain ($0)

If you are concerned about your untaxed capital gains and the most effective ways to transfer wealth to your heirs, contact our experienced New Jersey, Pennsylvania, New York, Florida and Minnesota Estate Planning Attorneys for a free consultation.

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