NCPA - National Center for Policy Analysis

Carryover Basis For Capital Gains May Replace Estate Tax

May 16, 2001

The tax bill passed by the House, H.R. 8, includes carryover basis provisions which would replace the estate tax. Under current law, capital gains on assets held until death are forever untaxed. The tax basis for assets is stepped-up, so that an heir selling the asset subsequently will only be taxed on the appreciation that occurs after death of the decedent.

Tax reformers criticize step-up basis as an unjustified tax benefit for those who hold assets until death, compared to those who sell the same asset during their lives. It also creates a "lock-in" effect by discouraging the elderly from selling assets.

But step-up basis prevents double taxation of assets at death -- first by the capital gains tax and again by the estate tax. And it enormously simplifies estate settlement.

When abolition of step-up was enacted in the Tax Reform Act of 1976 it proved to be a nightmare. Almost immediately, there was an outcry from lawyers and accountants, who found it impossible to comply with. In 1980, Congress repealed carryover basis retroactive to December 31, 1976.

But carryover basis has been included in the House-passed tax bill, and it will likely be in the Senate bill as well. It recoups some of the revenue lost to estate tax repeal and counters the argument that great wealth would be entirely untaxed.

It also includes limited step-up basis, which would keep estates too small to be subject to the estate tax from being worse off after repeal than they are now by allowing them to step-up their basis to the estate tax exemption level.

The carryover basis provision Congress appears ready to endorse may lead to a repeat of the 1976 experience, with almost immediate pressure for its repeal all over again.

Source: Bruce Bartlett, senior fellow, National Center for Policy Analysis, May 16, 2001.


Browse more articles on Tax and Spending Issues