Paul L. Caron

Wednesday, March 22, 2017

Schmalbeck, Soled & Thomas:  The Case For A Carryover Tax Basis Regime

Richard Schmalbeck (Duke), Jay A. Soled (Rutgers) & Kathleen DeLaney Thomas (North Carolina), Advocating A Carryover Tax Basis Regime (At Least for Now), 92 Notre Dame L. Rev. ___ (2017):

For close to a century, an important (but unfortunate) feature of the Internal Revenue Code has been a rule that the tax basis of any asset is made equal to its fair market value at death. Notwithstanding the substantial revenue losses associated with this rule, Congress has retained it for reasons of administrative convenience.

But from three different vantage points, pressure has been mounting to change what is commonly referred to as the “step-up in basis rule.” First, politicians and commentators have historically tied the step-up in basis rule to the estate tax on the theory that income be taxed only once, rather than twice. However, with the recent emasculation of the transfer tax regime, no estate tax is levied in most cases, while taxpayers routinely capitalize on the step-up in basis rule. On another front, technological advances have greatly simplified tax basis identification and record keeping, making a carryover tax basis regime eminently feasible, which it previously was not. Finally, in an era of growing income inequality, retention of a rule that primarily benefits the wealthy seems wholly unjustified, necessitating reform.

Congress essentially has two different reform options to consider, namely, a deemed realization rule or a carryover tax basis rule. While a deemed realization rule has many advantages, it appears to be politically unachievable, at least for the time being, due to liquidity and administrative concerns. On the other hand, in light of the fact that a carryover tax basis rule is widely utilized, vetted, and accepted in the related context of inter vivos gift giving, extending its application to transfers at death appears entirely feasible. Its institution would have many virtues, including improved administrability, equity, and revenue generation.

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Dale, I agree that incorporating inflation adjustments into basis calculations would be a mess. Though perhaps a reasonable formula or table could be created to take the hassle out of it. The bigger problem is record keeping. Too many long-held pieces of property don't have records that have survived. A FMV reset at a generational transition makes that problem go away.

And if only we could depend on the estate and gift tax going away. Not to mention the various state versions of the same tax. Somehow, I doubt the various governments will be too keen on giving up that windfall.

Posted by: ruralcounsel | Mar 23, 2017 8:29:23 AM

@ ohwilleke thanks
@ rural - if we do away with the estate tax, I can live with basis step up going away. Besides, as a policy idea, I don't think introducing inflation into the tax code is a good idea.

Posted by: Dale Spradling | Mar 23, 2017 6:34:30 AM

The step-up basis was, I thought, an imperfect way to account for inflation. Do away with the step-up basis, and you give the government an undeserved and unearned windfall, because of the inflation it failed to control over the decades property was held. The economic power of $1.00 in 1917 is about $299 in current terms.

Posted by: ruralcounsel | Mar 23, 2017 4:31:50 AM

@Dale Spradling You are correct. The estate tax generated $19.3 billion of tax revenues in 2014. The step up in basis for capital gains at death cost $60.4 billion of tax revenues in 2014.

Posted by: ohwilleke | Mar 22, 2017 11:51:31 AM

The author states that gathering carryover basis information from a decedent is easy to do. In fact, it is very difficult to gather tax basis information on a personal residence while the taxpayer is alive. It is impossible to do so if the taxpayer is deceased. Few mortals keep any basis information for tangible personal property. The only people with decent basis information for intangibles are those wealthy enough to keep all stocks in a brokerage account. Unless Congress is going to mandate a digital storage locker for tax basis information, this whole idea is unsound.

Posted by: J Kelly | Mar 22, 2017 7:34:42 AM

I have long thought the revenue loss from the estate tax basis step up (in most cases) exceeds any revenue gains from the estate tax. The math should be straight forward, there are far more people who receive inheritances than there are taxable estates. The answer, to me anyway, is to repeal the estate and gift tax and the basis step up on inherited property. Unfortunately, too many estate lawyers and life insurance brokers will have to find other work for this to pass.

Posted by: Dale Spradling | Mar 22, 2017 7:17:10 AM