ManicDDaily

No Step-Up

In dying this year, Dan Duncan appears to have become the first U.S. billionaire to leave a multi-billion dollar estate to his children and grandchildren free from U.S. estate tax.  This avoidance of U.S. estate tax does not result from charitable giving, nor from the clever use of U.S. estate tax loopholes, but from a curious quirk of the Bush tax cuts of 2001, which repealed the estate tax for persons dying in the year 2010.  Only.

Under the Bush tax cuts, the one-year 2010 estate tax repeal is “sunsetted” next year, 2011.  At that point, the federal estate tax will come back into force with a vengeance, with higher rates and lowered exemptions, limiting the amount passing to non-spousal and non-charitable heirs, without federal estate tax, to only $1 million.

What this means is that if you are a relatively wealthy person and your heirs are likely to have tried very hard to keep you alive on December 31, 2009, but may not try nearly so hard on December 31, 2010.   In other words, if you are a wealthy old person, or wealthy young person, trust no one this year!  Don’t let an heir touch a hair on your head!

For the last ten years, trust and estate attorneys have made jokes about the prospective 2010 effect of the Bush tax cuts, sure that the Federal Government would act to change the rules before the end of 2009.  But in December 2009 congressmen were so fearful of being tagged as voting for an increase in the notorious “death tax” that no agreement was reached.

This is not a post about the unfairness to wealthy people of a weird one-year loophole.  Nor is it about the dangers of allowing increasingly high concentrations of wealth in the society.  Nor even about the dangers to old rich people from greedy heirs.

No, this post is about how this year’s rules (surprise! surprise!) actually raise the prospective tax burden of the middle class and lower.   Here’s how it works:

(Because I’m a lawyer, I’m going to start out by saying that this is a vast oversimplification, even though it will sound very complicated.  I’m also going to say that nobody should rely on this post for tax advice.)

Actually, I just spent about four paragraphs writing my oversimplification and then, in sympathy for you, I cut it. I’ll just go for the juglar:

In 2009, a person could leave an estate of 3.5 million or less (not including bequests for spouses and charities), without federal estate tax.  Under the traditional (non-2010) rules, appreciated assets that were inherited got a “stepped-up” cost basis to their value as of the date of death of the decedent.  This meant that the assets could be sold by heirs with relatively reduced capital gains tax (or, if sold promptly, with none at all.)  This also means that in 2009, the heirs of a person with an estate of approximately 3.5 million or less did not have a federal estate tax burden, and actually had some federal income tax benefits, related to the death.

In 2010, the Bush tax rules offset the loss of fiscal revenue from the repeal of the estate tax by eliminating the capital gains benefits that had previously been granted on dying.   Just as there is no estate tax, there is, in 2010, no “step-up” in cost basis for the appreciated assets of the deceased.  For the very wealthy, this exchange of tax burdens is a bonanza—(i) because capital gains tax rates are considerably lower than estate tax rates;  and (ii) because capital gains tax is only assessed if gains are actually realized, i.e. when assets are sold.  Many wealthy heirs may not need to sell inherited assets, such as stock or jewelry or houses, or can offset the gains by realizing losses on other assets.

However, the loss of the capital gains step-up imposes additional tax costs on those less wealthy people whose estates would not have been subject to the federal estate tax under prior rules, but who now will have to pay higher capital gains taxes on the sale of inherited appreciated assets.   (Keep in mind that the lower cost basis will not get changed at the end of this year, so could affect sales far in the future.)

So once again (even after Bush leaves office), his tax policies favor the rich.

The amazing thing to me is that no one is talking about this.  (Yes, I know it’s complicated.)

Even weirder is the feeling I have that many lower and/or middle-class Americans, who seem to have a perverse habit of rooting for economic policies which do not, in fact, favor them, may be happy about the one-year repeal of the estate tax.  I imagine them thinking that it’s a blow against big government, not realizing, of course, that they may personally pay the price tag.

IRS CIRCULAR 230 Disclosure:  To ensure compliance with requirements imposed by the IRS, please be aware that any U.S. federal tax advice contained in this communication (including any attachments or enclosures) is not intended or written to be used and cannot be used for the purpose of (i) avoiding penalties that may be imposed under the Internal Revenue Code or (ii) promoting, marketing or recommending to any other person any transaction or matter addressed herein.