Jeb! Wrong on Estate Tax: Eliminating Carryover Basis Protects Rich and Punishes Middle Class

 

Presidential candidate Jeb Bush has put forth a tax reform plan and it contains many good proposals. He wants to be the champion for the middle class. There are also a number of very, very bad ideas.

Mr. Bush proposes to eliminate the estate tax. In return, he proposes to eliminate the “carryover basis” rule. Eliminating the estate will benefit very large estates so the Bill Gates and Warren Buffetts of the world would not have to pay estate tax. Great for their heirs. However, Mr. Middle Class would be subject to an income tax when he disposes of Grandma’s condo when he sells it after her death. Bad idea, very bad idea.

Let’s look at it more closely-----

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.

Some background on the estate tax is in order. In 2015, every person may leave or give away up to $5.43 million without owing any estate tax. As a practical matter, that means about 99.5% of all estates will NOT owe any federal gift/estate tax. 

Many conservatives refer to the estate tax as the ”death” tax and would like to abolish it. Liberals, of course, believe everything belongs to the state and would like to have as high a tax rate and lowest exemption level as possible. There are also a few in the middle, like me. I have no problem with a reasonable tax rate on very large estates. The dirty secret is that these very large estates through private foundations, charities and other such devices can largely blunt the effect of the tax and still more or less control the money from the grave.

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 sold based on the difference in value of the assets between the date of death value and the sales price.

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.

I would argue 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?

So, Jeb!, you got this one wrong. Keeping stepped up basis is for the middle class.