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Originally Posted by Rhotchkiss
I dont mind eliminating the step-up of basis on death to the extent that assets are passed tax free. In other words, if the estate tax exemption is $5mm, and someone dies and leaves a $5mm asset, with a $500k basis, to their heirs, I have no problem with the heirs taking the asset with a $500k carryover basis. That is sound tax policy - defer the tax until realization, not eliminate it. At the same time, I would fully expect that any asset subject to estate tax would be passed to heirs with a stepped up basis because tax has already been paid. That too is sound tax policy. Query what happens when an estate worth $20mm is passed, $5mm is exempt, and tax is paid on $15mm of wealth/value - how do you determine which assets get a step up and which get a carry over basis? I guess that is what regs are for.....
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Unlike most all the other tax law proposals they have been talking about, no one has put forth any real specifics yet as to exactly how eliminating the stepping-up of basis for inherited assets would be implemented and what, if any, effect it may have in regards to estate taxes or other possible taxes that may come out of all these potential changes they are proposing. And that is why I said this is an area to maybe keep an eye on since it is so uncertain.
As you said, it makes sense that any inherited assets that are subject to the estate tax would get passed through with a stepped-up basis, so they aren't subjected to a form of double taxation. But many would argue that the estate tax itself is already a serious violation of the no double taxation rule in that assets a person has acquired over their entire lifetime (with money they worked hard for and already paid tax on) for the benefit of themselves and their family, is being suddenly taxed again now that they have passed. But estate taxes are a form of excise tax and not an income tax, so therefore in the government's eye, I don't think they'd look at it as double taxation. The estate (and gift) tax exemption is in place for various reasons, like allowing people to pass some of their hard earned assets on to their heirs without the government imposing a politically unpopular estate tax on every single person that passes. Also, without such an exemption, just think of the increase in tax filings that would suddenly hit the IRS, not like they aren't already overworked, understaffed and underbudgeted with all the covid and stimulus activity and changes they are going through now. Historically, up to now, estate tax returns are only filed for about 1%-2% of the people that pass each year, and similarly, estate taxes paid each year only cover about 1%-2% of the federal annual budget.
So up till now, they kind of treated the estate tax exemption like the standard deduction for personal income tax purposes. You use both to reduce the amount ultimately subject to the respective estate/income tax, but both are still part of the tax base. And that is why under the current law, the portion of a deceden's assets that aren't actually taxed because they fall under this estate exemption amount are still considered as having been subject to the estate tax, just at a 0% estate tax rate, and are therefore still eligble for the step-up in basis to the decedent's heirs.
One of my concerns is that in the future they may change the estate tax laws so that inherited assets on which no estate taxes are paid because of the estate exemption do not get a basis step-up. Along with the great question you pointed out about how do you then decide which inherited assets get stepped-up and which ones don't in an estate that is partially taxable and partially not taxable (I can only imagine the treasury regs they would come with to explain how to do that), you would now have to have everyone keeping track of their tax basis for all their assets so when they pass on the executor of their estate can be responsible for letting all the heirs know what tax basis they now have in what they inherit. So for someone who leaves a lifelong card collection, the executor better hope they find the decedent kept great records so they can determine what the collection may have as a tax basis.
And the worst part is, if something like that does get enacted it will potentionally effect everyone, not just those making more than the $400K a year they have been alluding to. Let's face it, the government wants more money and just going after people making more than $400K a year may not cut it for what they need. Planning for and being concerned with estate taxes is something the average person doesn't ever really think about. Enacting new laws like this could change that, and possibly create a real nightmare and more headaches and work for accountants, attorneys, courts, the IRS, and anyone else involved with estates going forward.
And don't forget, they actually did away with the federal estate tax for one year, in 2010. Actually, Congress let it lapse due to their inaction on the issue. This also did away with the usual basis step-up rules for inherited assets that same year as a result. Congress could have gone ahead and just done away with estate taxes (and the basis step-up of assets) going forward then. But before the end of 2010, they finally enacted legislation to reinstate the federal estate tax laws in 2011 to approximately what they had been before 2010. They also gave executors of estates of people who passed away in 2010 the option of either choosing to file and pay estate taxes after all, and to therefore get the normal basis step-up, or to forego paying federal estate taxes and not get the normal basis step. I'm guessing a main reason that Congress decided to reinstate the estate tax laws as they had been was because even though it may only have brought in 1%-2% of the annual federal budget, they didn't want to take a chance and forego that normal cash flow stream.
I also remember 2010 was the year George Steinbrenner died and there was a lot of speculation as to whether or not they would pay the estate tax on his ownership of the Yankees. (See, even got a baseball reference in there to try and keep it on topic.) No idea which way they ended up going.
Bottom line is to watch this and see what they might end up doing tax-wise.