An Estate Tax Twist

[DjTj]

http://www.washingtonpost.com/wp-dyn/articles/A48150-2005Apr12.html

An Estate Tax Twist

Wednesday, April 13, 2005; Page A16

AS THEY DEBATE today whether to repeal the estate tax, House members should think about this: Repeal may actually hurt more family farmers and small businesses than it would help. And for many other people with big but not supersized estates, repeal would add cumbersome and costly new reporting requirements -- and could force them to pay more taxes, not less, than they would owe if the tax were frozen at the level it is slated to be in 2009.

Here's why. The plan to do away with the estate tax is paired with the kind of arcane adjustment that gets little notice during debate and then turns out to have big consequences. The change has to do with the way the value of inherited assets is calculated. Currently, heirs who inherit property -- anything from houses to stocks to jewelry to equipment -- don't have to worry about how much it originally cost or whether it was depreciated along the way. Rather, the property is valued as of the time of its inheritance; in tax talk, it has a stepped-up basis. So, for example, stock holdings that are sold by heirs aren't subject to capital gains taxes stretching back to the original purchase.

But a change inserted into the 2001 tax bill -- in part to keep the price tag down -- would modify this. Under the new rule, heirs who receive property worth more than $1.3 million total (surviving spouses get an extra $3 million cushion) would have to value the assets the same way as the original owner; this is what's called carry-over basis. While they wouldn't owe any estate tax, they could have to pay sizable capital gains taxes when the assets are sold.

As a matter of pure tax theory, this change might make sense. But in the real world it would be enormously difficult to administer; after all, the person who knows the original price of the asset is dead. Even for assets not being sold, there will be bills from lawyers and accountants for figuring out the proper valuation for estates worth over $1.3 million. According to estimates by the Joint Tax Committee, 55,000 estates won't get any extra tax benefit as a result of eliminating the estate tax but will have to file these complicated new accountings. Just what the country needs: a tax code that's even more burdensome and complex. By contrast, leaving the estate tax at its 2009 level, in which the first $3.5 million of every estate is exempt from taxation and the basis rule is left unchanged, would avoid this widespread hassle -- and, as we noted yesterday, still shield 99.7 percent of estates from tax.

In a magnificently ironic twist, this change could hit the very people estate tax repeal is supposed to help: family farmers and small-business owners. Farms, for example, tend to have land that's appreciated enormously and equipment that's been depreciated but that still has significant value. If the heirs hold on to the farm the valuation change won't have a big effect. But if they sell, as many do, their tax bill under "repeal" could easily end up being bigger than if the estate tax had been left in place. The Agriculture Department estimates that about 300 farm estates would have to pay estate taxes in 2009 but that (even based on farm values in 2001) about 400 farm estates would have unrealized capital gains greater than the $1.3 million exclusion. Lawmakers: Imagine what you're going to hear from your constituents if you do them this favor.

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I thought this was a really interesting point. Part of the benefit of the estate tax is a recordkeeping simplification - when you inherit stocks from your grandparents, you get to value them at the price you got them instead of the price your grandparents paid. In exchange for this step-up basis you pay an estate tax.

The estate tax is generally lower than the capital gains tax (and has a big standard deduction) so getting rid of this will actually increase the amount that inheritors will pay if they sell. Maybe it's more fair because at least you won't be taxed unless you sell, but I think I would rather have more money.

[FBChick]

In a magnificently ironic twist, this change could hit the very people estate tax repeal is supposed to help: family farmers and small-business owners. Farms, for example, tend to have land that's appreciated enormously and equipment that's been depreciated but that still has significant value. If the heirs hold on to the farm the valuation change won't have a big effect. But if they sell, as many do, their tax bill under "repeal" could easily end up being bigger than if the estate tax had been left in place. The Agriculture Department estimates that about 300 farm estates would have to pay estate taxes in 2009 but that (even based on farm values in 2001) about 400 farm estates would have unrealized capital gains greater than the $1.3 million exclusion. Lawmakers: Imagine what you're going to hear from your constituents if you do them this favor.

Actually, I think it's on par with what the repeal is meant to do, which is to protect those farmers that want to keep farming. Not to protect those that are trying to sell it all off. It's what they do now, because of the tax, not because they want to.

Example. Farmer has a high land/ equipment based farm, but that farm only profits little more then what is needed to for the family to live off of. When Farmer dies, his son inherits the farm and actually wants to keep on farming, but can't because the estate comes with a tax bill too large for the son to pay out of pocket, so his only recourse is to sell the land and or equipment just to pay the tax bill.

Honestly, I have no problems taxing those that just up and sell the estate, because I've never felt that was something so important to protecting. I mean looking at the info, the person still gets 1.5 million tax free, which in my book is a nice inheritance anyway. Though I do agree with this article on the issue of an increase in cost just trying to figure out how much tax is owed. Also huge questions on just how far back this rule would apply. A farm that has been passed down through 3 or 4 generations would be near impossible to tract down all the information needed. Or would you only account from the prior generation, and would that type of info even be available? Also this article makes no mention of debt on such assets, how does IT factor in and effect the final outcome?

[gbear]

A stealth tax increase eh?

Well, the states appraise land every few years. It sholdnt be to hard to figure out what it was when first appraised or anytime after that. I guess that solves the farming question. Every other business would be significantly harder though.

All of that being said, I would be in favor of just saying from here on out (or some recent date) with everything before that date being tax exempt. That would seem to make it easier to calculate, and in the long term should still provide the extra tax revenue. Afterall, that's kind of like making the bill like it was marketed to the public in tthe short term, but a tax increase in the long term. That might be the best way I've ever seen to get soe of the public to rally behind raising taxes.

[China]

Is there a provision that prevent people from having a clause in their will to liquidate all their assets into cash upon death and then distributing the inheritance as cash, thus avoiding capital gains?

Edit: now that I think about it that doesn't make sense, because upon selling the stocks at the time of death a capital gains tax would be due. Nevermind.