Paul L. Caron

Monday, April 12, 2021

Halperin: No Basis Step-Up For Marketable Securities With No Tax At Death

Daniel I. Halperin (Harvard), No Basis Step-Up for Marketable Securities With No Tax at Death, 170 Tax Notes Fed. 1709 (Mar. 15, 2021):

Tax Notes Federal (2020)In this article, Halperin proposes an innovative way to achieve realization, without any added tax burden at gift, death, or sale: collecting an equivalent tax in present value during the period the asset is held.

The Biden administration has indicated that it would end the egregious step-up in basis at death under section 1014. The step-up, combined with lack of gain recognition on property transferred to charities, allows wealthy households to escape taxation on a substantial percentage of their income. Importantly, measuring effective tax rates, without adding unrealized gains to the denominator, significantly understates the actual effective tax burden on those who hold appreciated assets until death or transfer them to charity to avoid tax on gains. In fact, those who have great wealth may have little or no reason to sell appreciated property. Risk can be mitigated by a charitable gift, a like-kind exchange for real estate, or the creation of an offsetting position that falls short of triggering a constructive sale. It is long past time to eliminate this enormous tax loophole.

A traditional argument against making death a realization event, however, is that it would trigger a large tax at death. Therefore, as a first step, this article proposes an innovative method of achieving the result of realization, without any additional tax burden at gift, death, or sale, by collecting an equivalent tax (in present value) during the period the asset is held. Although there would be an annual tax, unlike accrual taxation, this approach would continue the benefit of deferral, which accrual taxation would eliminate.

I show that, apart from the effect of a rate change, taxing the unrealized gain to basis each year, including the year of sale, can achieve the same result as a pre-death sale, even if property is not sold before death. (This is the “return-to-basis” approach.) As shown in Section I of this article, this can easily be achieved with marketable securities for which neither measurement nor liquidity would pose a problem. Section II explores alternatives for extending this treatment to nonmarketable assets as well.

If the return-to-basis approach is not enacted or is limited to marketable securities, as an alternative, I suggest (in Section III) substantially expanding the scope of so-called income in respect of a decedent (IRD), which denies the basis step-up. The current definition implies that the basis step-up should, for example, be denied for income that the decedent was entitled to before death when the tax on that income is deferred by a nonrecognition provision or an accelerated deduction, such as expensing or accelerated depreciation.

I conclude in Section IV with a brief discussion of the transition to the return-to-basis system.

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