The Gain That Dies With You
In the United States a fortune can grow for a lifetime and pass to the next generation without anyone ever paying income tax on the growth. Nothing about it is illegal. This essay explains, step by step and with numbers, how it works.
Ray Madoff, a law professor at Boston College, argues in The Second Estate (2025) that the American tax code has become two systems: one for people who live on what they earn, and one for people who live on what they own.[1] Her argument rests on a handful of rules that most people have never heard of, and the most important of them can be stated in one line: when someone dies, the gains on everything they own are wiped clean for tax purposes. That line hides a lot. This essay unpacks it, starting from what a gain is and how the tax system measures it, and then follows a fortune through borrowing, the estate tax, trusts and charity. A companion piece, Not Quite a Nobility, is a critique of the book itself.
A salary is taxed when it is paid; a gain, when it is sold
Take two people. Ana is a nurse who earns $80,000 a year. Bruno owns shares that rise in value by $80,000 a year. Both are $80,000 better off at the end of each year. The tax system treats them completely differently.
Ana’s income is taxed as it arrives. Her employer withholds income tax from every paycheck, plus 7.65 per cent for Social Security and Medicare, and pays the same 7.65 per cent again on her behalf. She has no choice about when to pay, and no way to put it off.
Bruno pays nothing. His shares are worth more, but in the language of tax law the gain has not been realized: he has not sold anything, so there is no transaction for the tax to attach to. If he never sells, he never pays. This is the realization rule, and it is as old as the income tax itself; the Supreme Court leaned on it in 1920, in Eisner v. Macomber, and in 2024, in Moore v. United States, it declined to say whether Congress could tax gains before they are realized.[2]
There are good practical reasons for the rule. Taxing Bruno every year would mean valuing everything he owns every year, which is easy for listed shares and very hard for a family business, a painting or a plot of land. It could force him to sell assets just to pay the tax. And his gain might vanish next year if the market falls. So almost every country waits until the sale.
Waiting is not, in itself, a gift. If Bruno sells in thirty years, he pays tax on thirty years of gains then. He has had the use of the money in the meantime, which is worth something (a tax postponed is an interest-free loan from the government), but the tax does arrive. The problem this essay is about is what happens when it never does. To see how that can happen, we need one more idea.
The receipt that the tax is measured from
When you sell something, the tax system needs to know how much you gained. It does that by subtracting what you paid from what you got. What you paid is called your basis (in Britain, the “base cost”; in Portugal, the valor de aquisição). Think of it as the receipt the tax system keeps for every asset you own.
A simple example. You buy 1,000 shares at $10 each: your basis is $10,000. Years later you sell them at $50 each, for $50,000. Your gain is $50,000 minus $10,000, or $40,000, and that is what is taxed, not the whole $50,000. The first $10,000 is just your own money coming back.
Gains on assets held for more than a year are taxed at lower rates than wages: 0, 15 or 20 per cent depending on income, plus a 3.8 per cent surcharge on investment income for people earning above $200,000 ($250,000 for a couple). So the top rate on a long-term gain is 23.8 per cent, against 37 per cent on wages, and gains pay no Social Security tax at all. On our $40,000 gain, a typical middle-income seller pays 15 per cent, $6,000; a rich one pays 23.8 per cent, $9,520.[3]
Everything that follows turns on one question: what happens to the receipt when the asset changes hands without being sold?
What happens to the receipt at death
Now the central example, the one behind the sentence in the deck. A woman buys shares for $10,000 in 1980. They do well, growing about 10.5 per cent a year, and by her death in 2026 they are worth $1,000,000. Her basis is still $10,000. The gain on her shares, the part that has never been taxed, is $990,000 (Figure 1).
Consider three things that could happen to those shares.
She sells them the day before she dies. Her gain is $990,000. At 23.8 per cent, she owes $235,620. Her children inherit what is left.
She gives them to her son while she is alive, and he sells them. A gift does not reset the receipt: the son takes over his mother’s basis of $10,000, which tax lawyers call carryover basis (section 1015 of the tax code). When he sells for $1,000,000, he has a gain of $990,000 and owes the same $235,620.[4]
She keeps them until she dies, and he inherits them. Here the rule changes. Under section 1014, an heir’s basis is not what the dead person paid but the value of the asset on the day of death. The son’s receipt now says $1,000,000. If he sells the next day for $1,000,000, his gain is zero and his tax is zero. His mother never paid tax on the $990,000, because she never sold. He never pays tax on it either, because, as far as the tax system is concerned, it happened before he owned the shares. The gain has not been postponed. It has been erased.[4]
That reset is called the step-up in basis: the basis steps up from what was paid to what the asset is worth. (If the asset has fallen in value, the basis steps down, and a loss is erased in the same way; for most large fortunes that is the rare case.) The dashed line in Figure 1 is the step-up. Figure 2 puts the three routes side by side, with two other countries for comparison.
An analogy may help. Imagine a taxi meter that runs for as long as you own an asset and is only read when you get out. The fare is the gain. The realization rule says you pay when you get out, not while you are riding. The step-up says that if you die in the taxi, the meter is reset to zero and your children get in for free.
Two consequences follow, and both matter more than the example suggests. First, the rule rewards holding on. An 80-year-old with a large unrealized gain has every reason never to sell, since selling costs 23.8 per cent and waiting costs nothing. Economists call this the lock-in effect, and it means that the older and richer a portfolio is, the less likely its gains are ever to be taxed. Second, the effect compounds across generations. The son starts with a fresh receipt at $1,000,000; if he too holds until death, the gain over his lifetime is erased as well.
A rule with reasons, most of them older than the problem
The step-up is not an accident or a recent loophole; it has been in the tax code since the 1920s. It had three defensible justifications.
The first was the estate tax. Since 1916 the United States has taxed large estates at death, and it seemed unfair to tax the same wealth twice, once as an estate and once as a gain. The estate tax was meant to be the tax at death.
The second was record-keeping. To use the dead person’s basis, the heir needs to know what was paid, sometimes decades earlier, for shares, land or a business. Congress tried it once. The Tax Reform Act of 1976 replaced the step-up with carryover basis for inherited assets; the outcry over lost records was immediate, Congress postponed the rule in 1978 and repealed it, retroactively, in 1980, before it had ever taken effect. A tax scholar later called the episode “one of the greatest legislative fiascoes in the history of the income tax”.[5] (In 2010, when the estate tax lapsed for one year, carryover basis briefly returned for estates that chose it; it did not survive either.)
The third was liquidity. If death were treated as a sale, a family that inherits a farm or a small firm might owe a large tax bill with no cash to pay it, and might have to sell the thing it inherited.
All three are real. But the first assumes an estate tax that applies to the estates in question, and, as the next sections show, that is no longer true for almost anyone.
A benefit worth tens of billions, tilted to the top
The Joint Committee on Taxation, Congress’s own scorekeeper, estimates that not taxing gains at death will cost the federal government $72.5 billion in 2026, about a quarter of everything it collects from taxes on capital gains.[6] That is a “tax expenditure” estimate: what the rule costs if nothing else changed. What a repeal would actually raise depends on how people react, and would be less.
Who receives the benefit? The Congressional Budget Office estimated that in 2019, 56 per cent of it, about $22 billion, went to the richest fifth of estates, and $7 billion to the top 1 per cent of estates alone.[6] The other side of that number should be said too: about 44 per cent went to the other four-fifths. A family that inherits a house bought in 1985, or a modest portfolio, also benefits from the step-up, which is why every serious reform proposal comes with a large exemption. Gains on a family home are already mostly exempt during life (up to $250,000 per person on a main residence), so the benefit at the top is mostly about shares and businesses.
Buy, borrow, die — and what the data say about it
If gains are only taxed when you sell, and erased if you never sell, the obvious question is how the very rich pay for their lives without selling. The popular answer is a three-word phrase: buy, borrow, die. Buy assets that grow. Borrow against them to live, since a loan is not income and is not taxed. Die, and let the heirs sell enough of the stepped-up assets to repay the loans, with no gain to tax.
The phrase is accurate as a description of a strategy that some people use. Banks lend against share portfolios at low rates, and founders of large companies are known to pledge their shares as collateral. But as a description of how the rich as a group avoid tax, it is misleading, and the reason is instructive.
The economists Edward Fox and Zachary Liscow measured, for two decades of US household data, how much the top 1 per cent of wealth-holders borrow each year. It comes to about 1 to 2 per cent of their economic income, by which they mean the income the tax system sees plus the year’s new unrealized gains. Their new unrealized gains over the same period were 20 to 40 times larger than their borrowing.[7] Most rich people do not need to borrow to live. They have salaries, dividends, interest and business profits, all taxed, and they spend less than those bring in. The untaxed part is the growth of the assets they never touch. Fox and Liscow suggest the strategy should really be called buy, save, die.
Figure 3 shows the other half of their finding, which is easy to miss. For the top 1 per cent as a whole, the income tax sees about 60 per cent of their economic income, or 71 per cent once the part of their gains that is just inflation is taken out.[7] The rich, taken together, are not untaxed. A large slice of their income escapes, and that slice is concentrated in the people whose wealth is mostly one company’s shares.
At the very top the picture is starker, because founders’ fortunes are made almost entirely of unrealized gains. In 2021 the newsroom ProPublica obtained IRS records for the 25 richest Americans. Between 2014 and 2018 their combined wealth rose by about $401 billion, according to Forbes; they paid $13.6 billion in federal income tax, which ProPublica called a “true tax rate” of 3.4 per cent.[8] That rate is ProPublica’s construction, not a legal one: it divides tax paid by the rise in wealth, which the law does not count as income. Nobody named was accused of breaking the law. But that is the point Madoff’s book makes: none of it requires breaking the law.
The estate tax, and how it shrank
If the step-up was justified by the estate tax, everything depends on how much the estate tax still does. It works like this. When someone dies, everything they own is added up. Anything left to a spouse or to charity is deducted. What remains, above an exemption, is taxed at 40 per cent. In 2026 the exemption is $15 million per person, and a married couple can combine theirs, so a couple can leave $30 million to their children without any estate tax. The exemption was made permanent and indexed to inflation by the budget act signed in July 2025; without it, the exemption would have fallen to about $7 million in 2026.[9]
Twenty-five years ago the picture was very different (Figure 4). In 2001 the exemption was $675,000, about $1.2 million in today’s money, and the top rate was 55 per cent. About 51,800 estate tax returns filed that year owed tax. For people who died in 2023, the Tax Policy Center estimated about 4,000 taxable estates, out of roughly 3 million deaths: roughly one death in 750.[10] Estate and gift taxes together now bring in well under 1 per cent of federal revenue; the book puts the figure at about half a per cent.[1]
Now put the two rules together. The step-up applies to every estate, of any size. The estate tax applies to about one in 750. For the other 749, the justification for the step-up (that the wealth is taxed at death anyway) does not apply: the gains are erased and nothing replaces them. Even for the estates large enough to pay, the step-up still erases the gains in full while the estate tax, as the next section shows, often reaches only part of the value.
How large estates shrink before they are counted
A 40 per cent tax on everything above $15 million sounds substantial. In practice, large fortunes are arranged long before death so that much of their value is either outside the estate or counted at less than it is worth. Madoff argues that Congress has not seriously closed these routes since 1990.[1] Three of them show the logic. They are described here at the level of how they work, not how to set them up.
Freezing the value. The most widely used device is the grantor retained annuity trust, or GRAT. A wealthy person puts shares into a trust for, say, two years, and the trust pays them back in instalments that add up to the original value plus a modest interest rate set by the IRS. If the shares grow faster than that rate, the excess stays in the trust and passes to the children free of gift and estate tax. If they do not, the shares simply come back and nothing is lost. Because the payments back to the owner are set equal to what was put in, the taxable gift can be made worth zero. In 2000, in a case brought by Audrey Walton, widow of Walmart’s founder, the Tax Court accepted such a “zeroed-out” GRAT, and the IRS stopped contesting the point in 2003.[11] The device works best with volatile assets, such as the shares of a young company, and can be repeated year after year. (Mrs Walton’s own trusts, as it happened, passed nothing on: Walmart shares underperformed.)
Discounting the value. If a family puts its assets into a partnership or company and the children each receive minority stakes, each stake is valued for tax as what an outsider would pay for a small share that controls nothing and cannot easily be sold. That is less than the stake’s proportion of the assets inside, sometimes much less. The family as a whole still controls everything; the tax return sees a pile of discounted fragments.
Leaving it in trust for ever. A separate tax, on transfers that skip a generation, is meant to stop families from avoiding the estate tax by leaving money in trust for grandchildren. It has its own exemption, also $15 million per person. Many US states have abolished or stretched the old rule against perpetuities, which used to force trusts to end within roughly a lifetime, so a trust funded within that exemption can now last for generations, with its growth outside every future estate. These are often called dynasty trusts.
Underneath all three is the step-up. Assets held until death escape the gains tax whatever the estate tax does, and the estate tax itself can be thinned with planning. A very large fortune can therefore pass on with an effective rate far below the 40 per cent headline, and the growth before death untaxed throughout.
The inheritance itself is not income
There is a third gap, and it is the one Madoff’s book makes most of. The American definition of income is famously broad. In 1969 a couple in Ohio bought a used piano for $15 and found $4,467 in old banknotes inside. A federal court held that the money was taxable income, and it was.[12] Gambling winnings are income. A lottery prize is income. Prizes and awards are income.
But section 102 of the tax code says that gifts and inheritances are not income for the person who receives them.[4] A $50 million inheritance arrives with no income tax at all. The reasoning was, again, that the estate tax would deal with it at the other end. With the estate tax reaching one death in 750, the effect is that an heir’s windfall is treated more gently than a nurse’s overtime or a found banknote in a piano.
Giving away a gain that was never taxed
Charitable giving has its own version of the step-up. Go back to the woman with the $1,000,000 of shares bought for $10,000. Suppose that instead of keeping them she gives them to a charity. Two things happen. She can deduct the full $1,000,000, the market value and not the $10,000 she paid, from her other income (within limits: up to 30 per cent of her income in a year, with five years to use the rest). At the 37 per cent top rate that deduction is worth up to $370,000 in tax saved. And the $990,000 gain is never taxed, because she never sold; that avoids $235,620. Together the tax benefit comes to about $605,620, or 60 per cent of the gift. A wage earner who gives $1,000,000 in cash gets the deduction but not the second part. Madoff, in an interview about the book, put the benefit for wealthy donors at up to 60 per cent of a gift.[13]
The money does not even have to reach a working charity. A private foundation, controlled by the family, must pay out about 5 per cent of its assets a year. A donor-advised fund, an account held at a sponsoring charity (many are run by large investment firms), gives the donor the full deduction at once and has no payout rule at all: the donor recommends grants whenever they like, or not. Madoff estimates that the charitable deduction alone cost $64 billion in 2024, and that the full cost, counting the untaxed gains, is higher; she argues that tax benefits should be tied to money actually reaching active charities.[13] Charitable giving does real good, and much of it would happen without any tax break. The question the book raises is narrower: why the public subsidy is largest for gifts that may sit unspent for years, and for the donors who already pay least on their gains.
Following one fortune from start to finish
It may help to put the pieces in order, as one fortune would meet them.
Set that beside Ana, the nurse. Her income is withheld at source every month, with payroll taxes on top, and nothing about the timing is hers to choose. That is the core of Madoff’s claim of two systems. It is not that the rich pay lower rates on the same income. It is that a great deal of what makes them richer is never treated as income at all, and that whether and when it is taxed is largely up to them.
What could be done, and what each option costs
The proposals on the table differ mainly in where they put the tax and how they deal with the old objections: records, liquidity and double taxation.
Carryover basis. The heir keeps the dead person’s receipt, just as with a lifetime gift. Nothing is taxed at death; the gain is taxed when the heir sells. This is gentle on liquidity but leaves the lock-in in place, now inherited: heirs, too, have reason to hold for ever. It is also the option that failed in 1980, mainly because of the records problem, which modern brokerage records have largely solved for listed shares but not for land or private businesses.[5]
Death as a sale. Treat every death, and every gift, as if the assets had been sold at market value, and tax the gain on the dead person’s last return. This is what Canada has done since 1972, when it abolished its federal estate tax and began taxing gains at death instead; property left to a spouse can roll over with the tax deferred, and a main home is exempt.[14] In the United States, the Biden administration proposed a version in 2021, with a $1 million exemption per person on top of the existing exemption for homes, and it did not pass.[15] This option ends lock-in, since waiting no longer pays, and it is the one Madoff supports. Its costs are the liquidity problem for illiquid assets (usually handled by letting tax on family businesses and farms be paid over many years) and the valuation of anything that is not listed.
Inheritances as income. Tax what heirs receive as income, at ordinary rates, above a lifetime exemption. Madoff proposes this in place of the estate tax, with an exemption of perhaps $1 million.[16] It answers the found-banknote absurdity directly. Its weakness is the one every tax on transfers shares: it must still value what is transferred, and it must deal with the trusts, discounts and annuity devices that hollowed out the estate tax.
Taxing gains as they accrue. Tax the very richest on their gains every year, sold or not, as in the 2022 proposal for a minimum tax on households worth more than $100 million or the wealth taxes proposed by Senators Warren and Sanders. This goes straight at the problem but faces the hardest valuation questions, and, since Moore, an open constitutional question.[2] Madoff rejects it.
Taxing loans. Treat large loans against appreciated assets as a sale of those assets. This is aimed at buy, borrow, die specifically. Given that borrowing is a small part of the story (Figure 3), the Yale Budget Lab concludes that loan-focused reforms have “somewhat limited revenue potential”.[17]
Two cautions apply to all of them. Ending the step-up while keeping a very low rate on gains changes less than it seems; raising the rate on gains while keeping the step-up makes holding until death even more attractive. The reforms work as a package or not well at all. And part of any long-held gain is just inflation: a share bought for $10,000 in 1980 would need to be worth about $40,000 today merely to have kept its value. Taxing that part as a gain is a fair objection, and is one argument for indexing the basis to inflation if gains are taxed at higher rates.
The same rule, closer to home
Readers in Portugal should not assume this is an American curiosity. Portugal has its own step-up, and it is more generous.
Under article 45 of the Portuguese personal income tax code (CIRS), when someone acquires an asset for free, by gift or inheritance, its acquisition value for any future capital gains tax is the value used to assess stamp duty (imposto do selo) on the transfer; for an inheritance, the date of acquisition is the date of death.[18] So an heir who sells shares inherited from a parent is taxed only on any gain after the death. Everything gained during the parent’s life is erased, exactly as in the American example. For property the effect is partial, because the value used is usually the tax registry value (valor patrimónial tributário), which is often below the market price.
And there is no backstop at all for close family. Portugal abolished its inheritance and gift tax at the start of 2004 and replaced it with a 10 per cent stamp duty on gratuitous transfers, from which spouses, children, grandchildren and parents are exempt.[18] A Portuguese fortune passed from parents to children therefore pays no tax on the transfer, of any size, and its accumulated gains are wiped clean. The Portuguese case differs from the American in scale rather than kind: the very largest Portuguese fortunes are mostly business equity, held by a small number of families, as Who Gets the Profits showed. The question Madoff asks of the United States, why the growth of what people own is treated so much more gently than what they earn, applies here too; Earned and Unearned looked at it from the side of who earns what.
Postponed is not the same as forgiven
Most of the rules described here have honest origins. Waiting to tax gains until sale avoids valuing everything every year. Resetting the basis at death once avoided taxing the same wealth twice and spared heirs from digging through old records. Excluding inheritances from income left the job to the estate tax. Each rule assumed the others. Over a century, the pieces drifted apart: the estate tax shrank to one death in 750, the trusts that thin it were left in place, and the step-up kept erasing gains for everyone.
The result is the one in Figure 2. The same $990,000 gain can cost $235,620 or nothing, depending only on whether its owner sold it before death or after. In a system where most people’s income is taxed the moment it is paid, that choice is available mainly to those who own large amounts of assets and can afford to hold them. A tax that is postponed until the sale is a reasonable rule. A tax that is postponed until the sale and then forgiven at death is, for practical purposes, an exemption, and the largest beneficiaries are those whose wealth is mostly made of gains.
Whether that should change, and how, is a political choice, with real costs on each side: valuation, liquidity, family businesses, the risk of driving capital elsewhere. But the choice should be made with the mechanism in view. The step-up is not a technicality. It decides whether a fortune’s growth is ever taxed.
This piece was written collaboratively with Claude Opus 5.5 (Anthropic): human specification, editorial direction and critical review; machine research, analysis and drafting. The worked examples and figures are computed by scripts/second_estate.py (results in docs/second-estate-results.json, figures in docs/second-estate-figures.html); they apply stated rules to a stylised asset and are not data. US rules are as of October 2026; Canadian and Portuguese rules are summarised, not exhaustive. The description of the book relies on the publisher’s summary, published reviews and interviews with the author. Trusts and other planning devices are described at the level of how they work, not how to set them up. Nothing here is tax advice. The cover is computed by the same script.
Authored by: Luis Matos Ferreira — Physicist, Developer, Writer
- Not Quite a Nobility — a critique of Ray Madoff’s The Second Estate.
- Earned and Unearned — how work and ownership share income in Portugal.
- Who Gets the Profits — where the income that is not wages goes.
- R. D. Madoff, The Second Estate: How the Tax Code Made an American Aristocracy, University of Chicago Press, 2025; publisher’s page. Figures attributed to the book as reported in A. Untereiner’s review, The Burton Book Review.
- Eisner v. Macomber, 252 U.S. 189 (1920); Moore v. United States, 602 U.S. ___ (2024), which upheld a tax on undistributed foreign corporate income and expressly left open whether unrealized gains may be taxed.
- Internal Revenue Code, sections 1(h) (capital gains rates) and 1411 (3.8% net investment income tax); 2025–2026 thresholds.
- Internal Revenue Code, section 102 (gifts and inheritances excluded from income), section 1014 (basis of property acquired from a decedent) and section 1015 (basis of property acquired by gift); Cornell LII.
- Tax Foundation, “Biden’s proposal to tax unrealized capital gains at death”; Greenleaf Trust, “Stepped-up basis: a short history”; L. Zelenak quoted in The Denver Post, 5 August 1999. Carryover basis: Tax Reform Act of 1976, postponed by the Revenue Act of 1978, repealed by the Crude Oil Windfall Profit Tax Act of 1980.
- Peter G. Peterson Foundation, “What is stepped-up basis on capital gains and how does it affect the federal budget?”, 2024, citing Joint Committee on Taxation tax expenditure estimates and Congressional Budget Office distributional estimates for 2019.
- E. Fox and Z. Liscow, “The Role of Unrealized Gains and Borrowing in the Taxation of the Rich”, working paper, January 2025; summarised by the Tax Policy Center in “The rich’s real tax trick isn’t ‘buy, borrow, die’”.
- J. Eisinger, J. Ernsthausen and P. Kiel, “The Secret IRS Files”, ProPublica, 8 June 2021.
- Haynes Boone, “Federal estate, gift and GST tax highlights from the One Big Beautiful Bill Act”, 2025; Morgan Lewis, “Estate tax alert: new $15 million federal exemption becomes law”, August 2025.
- IRS Statistics of Income, estate tax filing-year tables (2001: 108,071 returns, 47.9% taxable); Tax Policy Center, “How many people pay the estate tax?” (estimate for 2023 decedents).
- Walton v. Commissioner, 115 T.C. 589 (2000); IRS Notice 2003-72; summary.
- Cesarini v. United States, 296 F. Supp. 3 (N.D. Ohio 1969), affirmed 428 F.2d 812 (6th Cir. 1970).
- B. Gose, “How the rich use philanthropy to dodge taxes”, interview with Ray Madoff, The Chronicle of Philanthropy, October 2025.
- Income Tax Act (Canada), subsection 70(5) (deemed disposition at death) and 70(6) (spousal rollover); Canada Revenue Agency guidance on the final return.
- US Treasury, General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, May 2021; summarised by the Tax Foundation (source 5).
- Madoff’s proposals as summarised in Untereiner’s review (source 1) and in E. M. Jensen, “A Fairer Tax System?”, Civitas Outlook, 21 November 2025.
- The Budget Lab at Yale, “Buy-Borrow-Die: options for reforming the tax treatment” (policy options paper).
- Código do IRS, artigo 45.º; Autoridade Tributária, binding information PIV 14147; Código do Imposto do Selo, artigo 6.º (exemptions) and General Table item 1.2; Decreto-Lei n.º 287/2003, which abolished the inheritance and gift tax from 1 January 2004.
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