​Why Obama wants to kill the "angel of death" tax loophole

Nothing may be certain but death and taxes, but that doesn't seem to cover loopholes.

In his State of the Union speech on Tuesday, President Obama proposed closing the so-called "angel of death" loophole, a tax break critics say unfairly benefits the wealthiest Americans.

"Everyone who sells assets pays a capital gains tax," Frank Clemente, executive director of Americans for Tax Fairness, said in a statement to CBS MoneyWatch. "Why should the heirs of the wealthiest Americans be exempt from this tax? That flies in the face of the purpose of inheritance taxes -- to limit the accumulation of huge amounts of wealth by millionaires and billionaires and to help fund the critical services we all depend on."

In other words, why should someone who sells an asset just before he dies owe capital gains, while another person who holds off on a sale until after death is able to sidestep the same tax?

Obama unveiled his plan to reform capital gains taxes as one element in his agenda to boost the middle class. Taking higher taxes from top income-earners would enable the government to provide tax breaks for the middle class and provide benefits such as tax credits for education.

Also called the trust-fund loophole, the "angel of death" loophole provides tax relief to heirs who inherit stock and other assets that would otherwise be subject to capital gains tax. The loophole allows those assets to pass tax-free to heirs, who receive the stock on a "stepped-up basis." Once those shares become an heir's property, all past capital gains or losses are wiped clean.

This loophole has drawn fire because it allows people who have been able to accumulate capital to pass it on tax-free to their heirs. The accumulation of wealth by the richest Americans has been helped by a U.S. tax code that taxes capital at a lower rate than income. Such tax breaks have been cited as one reason why America's wealth inequality has reached what economist Thomas Piketty called "spectacular" heights.

The world's richest 1 percent will control most of the world's wealth by next year, Oxfam reported this week. A study the anti-poverty group also found that one-third of billionaires start out life with a silver spoon firmly planted in their mouths, having inherited all or some of their wealth. Real wages for American workers, meanwhile, have actually declined almost 8 percent since 1973, according to Pew Research.

So how many Americans would be affected if the "angel of death" loophole goes to an early grave? According to the White House, 80 percent of its proposed capital gains tax reforms, of which closing the trust fund loophole is just one, would hit the top 0.1 percent of earners.

That segment counts only 160,000 families, who typically have assets of at least $20 million, according to economists Emmanuel Saez and Gabriel Zucman. "Hundreds of billions of dollars" in capital gains tax are lost each year because of the loophole, the White House said.

But wouldn't the proposal also unfairly target middle-class families who have worked hard to save and pass on assets to their heirs? Actually, no. The White House's proposal includes limits that will exempt the middle class, given that assets of up to $200,000 per couple, or $100,000 per individual, could still pass tax-free to heirs, as well as $500,000 per home.

Inherited and small, family-owned businesses would also be exempt from capital gains tax, unless and until that business is sold, the White House said. That means that if a mother leaves $25,000 in IBM stock to her daughter, for instance, that wouldn't be subject to the capital gains tax, nor would a farm passing between generations.

"Capital gains are hugely concentrated among the rich," Len Burman, the director of the Tax Policy Center, wrote about Obama's proposal in a blog post. "Only the richest of the rich can afford to hold onto substantial shares of their wealth until they die."

Most Baby Boomers won't see inheritances anywhere near that threshold, according to a 2010 study from the Center for Retirement Research at Boston College for the MetLife Mature Market Institute. The median inheritance for the generation, whose parents are now in their 70s and 80s, will be $64,000.

Of course, the focus on tax reform is likely moot, given the Republican-controlled Congress.