NCPA - National Center for Policy Analysis

A Fate Worse Than Death (Tax)

August 4, 1999

While some have lauded the House for voting to repeal the estate tax in 2009, analysts point out that they voted to replace it with something potentially worse: carryover basis.

Capital gains that pass through estates aren't taxed. When heirs sell an inherited asset, they pay capital gains taxes only on any gain since they received it. This is called "step-up basis," because the value of an asset for tax purposes is stepped up at death.

Critics of step-up basis have tried to eliminate it for decades, contending that it lets wealthy people get, in effect, a zero tax rate for assets that pass through their estates, and creates economic inefficiency by stifling the flow of capital.

So, in 1976, Congress sought to fix it by instituting carryover basis, forcing heirs to pay taxes on gains from the date of original purchase, not from the date of death.

  • Under step-up basis, a share of stock purchased for $10 that was worth $100 at death would be free of capital gains taxes.
  • An heir later selling the stock for $105 would pay tax only on the $5 gain since receipt.
  • But under carryover basis, the heir would be require to pay tax also on the $90 gain during the life of the original purchaser.

But carryover basis never actually took effect. It was difficult for executors and heirs to determine what the original price of the assets was, and it represented a new layer of taxation on estates. In 1980 it was repealed, and legal scholar Lawrence Zelenak called it "one of the greatest legislative fiascoes in the history of the income tax."

Now, while the House plans eliminates the estate tax, it implements carryover basis. Economists object that:

  • The same administrative problems that arose 20 years ago will still be present.
  • Because eliminating the estate tax also means eliminating the tax avoidance tools that are part of the law, it will be harder to avoid paying capital gains taxes if carryover is reinstituted.
  • In effect, the House has created a flat tax for estates: the top estate tax rate of 55 percent is being effectively lowered to 20 percent, the top rate for capital gains.
  • Thus, the House isn't abolishing the estate tax, just replacing it with another and adding far more confusion into the bargain.

Source: Bruce Bartlett (NCPA), "The Haunting: Estate Tax Won't Die," Los Angeles Times, August 3, 1999.


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