Obama attacks Stepped-Up Basis: Wants to Tax Income at Death

The Obama Administration is renewing its assault on the taxpayer. The President will propose during Tuesday's State of the Union address raising the capital gains rate on top income earners and changing the tax treatment of assets held at death.

The centerpiece of the President's tax proposal is an increase in the capital gains rate on couples making more than $500,000 per year to 28 percent. The top capital gains rate has already been raised from 15 percent to 23.8 percent during Obama's presidency.

Obama also wants to close what the administration is calling the "trust fund loophole," a change that would require estates to pay capital gains taxes upon death.

It is the last one that is grossly misrepresented as it has nothing to do with “trusts” and it has nothing to do with inheritance received. It is an income tax issue. It is purely an attempt to raise taxes to enlarge government. It has nothing to do with the middle class (except to raised money at death). 

In order to understand this proposal it is important to separate the income tax from the estate tax. The federal estate tax does not impact all that many estates even though the estate of every U.S. citizen is subject to tax upon death. Impact in the sense the decedents estate has to cough up addition dough to the government for dying and having property. However, there is a lurking income tax issue out there that goes along with it and it is a sneaky one.

Let us try to put this in context by example.

Every asset has a basis, usually its cost. If I buy a tractor for $100, it has a basis of $100 and I use this amount for depreciation in my business. Under the gift rules, if my aunt gives me a share of stock, which she paid $100 for 10 years ago but now worth $1000, my basis is $100, and if I sell it for $1000, I have a $900 gain which would be included in my income taxes.  This is called ‘carryover basis’.

Under the estate tax, an asset acquired from the same aunt from her estates is “stepped-up.” That is to say, the assets in an estate and the subsequent beneficiaries receive a new income tax basis equal to the fair market value of the assets on the date of the decedent’s death, (or on an alternate valuation date an estate may elect on the six-month anniversary date of a decedent’s death.) Accordingly, a beneficiary will pay income taxes on any received assets when sold based on the difference in value of the assets between the date of death value and the sales price. There is no tax until the asset is disposed. In the above example instead of gifting the stock the aunt conveys it at her death, the beneficiary gets a basis of $1000 and upon it sale of $1000, pays no income tax because there is no gain. What a great system. One of the few ways to avoid tax on appreciated property but, of course, someone has to die. 

The Federal Treasury forfeits a substantial amount of revenue by not taxing the gain on assets held until death. In fact, according to the Office of Management and Budget, it is the fifth-largest existing “tax expenditure.” The entire concept drives liberal crazy. Most revenue estimates put the loss to the Treasury of around $60 billion a year, although it really not possible to know with more certainty as data from all people who receive property from a decedent is not verifiable particularly where an estate tax return is not required to be filed.

Tax reformers, do-gooders and assorted liberals have been trying to ace out stepped-up basis for years. They succeeded in Tax Reform Act of 1976 but installing a type of carryover basis regime and eliminating stepped-up basis. However, led by Senator Harry F. Byrd Jr. (I-VA), the provision was suspended and eventually repealed. There is a litany of reasons carryover basis advocates want to repeal of stepped-up basis. Equally there are arguments on the other side. However, it all gets down to the money. Government desire for more and more money is insatiable.

The Obama proposal goes beyond elimination “stepped-up basis”. It calls for a realization event at death, which means the asset will be deems sold, and any untaxed appreciation will be recognized as gain. So in my example, even though the aunt dies and passed on the asset, which is unsold by the beneficiary, there will be a substantial income tax. The Obama proposal will be littered with income levels, carve outs and exceptions but the fact remains a person who dies will have all his property that has appreciated subject to income tax. A pretty horrible and drastic concept and a deviation from long established tax principles. 

Preserving stepped-up basis is much more important to the average taxpayer than what ever the tax rates are on mega-estates. This is an income tax issue after all. Normal taxpayers who inherit property do not always know what the basis is to the property received and why subject the property to the estate tax and then to the income tax? This is particularly true when there is no actual disposition of the property except caused by the transfer at death.

These are uncertain times but any big tax expenditure is in jeopardy in a climate of tax reform, however it is defined.  Repeal of stepped-up basis is not necessarily an immediate tax hike that can be felt by everyone but it is a tax increase. Instigating an income tax at death goes far beyond this concept.  

This is a serious proposal. It is designed for political purposes but it is doubtful it will see the light of day in the Republican Congress. However, it was never intended to be. 

Comments

[Sunshine]

Very nice presentation. Obama must be joking on this