Tuesday, October 11, 2005

The Next Stealth Tax Hike

The Bush Administration and Congress are currently negotiating the terms of the elimination of the estate tax. In April of 2005, the House of Representatives passed a permanent repeal of the estate tax. The Senate will soon vote on a bill eradicating the estate tax entirely. However, according to the IRS, "Most relatively simple estates (cash, publicly-traded securities, small amounts of other easily-valued assets, and no special deductions or elections, or jointly-held property) with a total value under $1,000,000 do not require the filing of an estate tax return."

But in order to eliminate the estate tax, Congress and the Bush Administration have introduced a much more sinister and larger tax bonanza for the federal government. This windfall comes from the elimination of the "stepped up" basis on inheritances. In 2010 heirs lose the advantageous step up in cost basis— a horrific compromise. In 2010, when the estate tax is scheduled to "go away" at least for one year, it is replaced with an insidious carry-over basis system which penalizes far more taxpayers than the estate tax ever did.

After December 31, 2009, the stepped up basis will no longer apply. There will be a new requirement to file a return known as a Section 6018 return, the purpose of which is to report the cost basis of property to the heirs of the property. The basis of property acquired from a decedent will then be the basis in the hands of the decedent, or the fair market value of the property at the decedent's death whichever is less.

Let me provide an example of current treatment and the revised treatment of inheritances of property. At this time, suppose that your grandfather has property that he purchased for $20,000 in 1980 that has a current market value of $50,000. In the event of his death and the provision of this land to you in his will, you are allowed to inherit the land and sell immediately for $50,000 with no taxes due the federal government. In other words, you are entitled to a "stepped up" basis or the valuation of the property at the time of your grandfather’s death. Thus your gain is zero—the sales price $50,000 minus the stepped-up basis of $50,000.

In 2010, this favorable tax treatment is eliminated. Thus, you inherit the same property, but with a basis of $20,000 (no step-up in basis). Upon the sale for $50,000 you now owe the federal government taxes on the gain of $30,000 ($50,000 sales price minus your grandfather’s basis of $20,000). We had this same system in 1976, and it was repealed in 1978 because it was too complex and unworkable since people died without basis information.

Like the introduction of the AMT (alternative minimum tax), the elimination of the stepped up basis will provide a huge revenue windfall for the federal government since many more taxpayers are subject to inheritances that benefit from the stepped up basis than benefit from the elimination of the estate tax. This significant change has been largely unreported by the news media since it requires an IQ above room temperature to understand (analogy borrowed from my friend Ed). My advise to you---get your grandfather to keep good tax records, or die before January 1, 2010.

Ernie Goss

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