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April 04, 2009

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There's another issue that goes along with this. When you inherit investments, your cost basis is the value at the time of inheritance, not the basis of the person you inherit from. All of the gains between the two are never subject to the capital gains tax.

This is something I'd like to see changed, even though I stand to benefit from it when some of my long lived relatives finally die off. It's particularly egregious for the size estates that are benefiting from this amendment. Though, the last time they tried to pass this, they included a clause to eliminate adjusting the basis, but forgot to mention that that meant that it would increase taxes on far more people than it would cut them for.

Linky for the below-

Fox News was talking about this the other day:

Republicans argue this tax doesn’t just strike the wealthy.

“It destroys a lot of small businesses and a lot of family farms and ranches in America,” said Sen. John Ensign, R-Nev.

CBPP says:
"Despite the oft-repeated claim that the estate tax has dire consequences for family farms and small businesses, no evidence supports that charge. Indeed, the American Farm Bureau Federation acknowledged to the New York Times several years ago, when the estate tax was more expansive than it is today, that even then it could not cite a single example of a farm having to be sold to pay the estate tax."

I favor an estate tax - even one with a high rate.

It levels the playing field from generation to generation. It makes it difficult for a permanent overclass to form. Dynamic individuals will arise in every generation who will amass fortunes. Good for them. But they have no need for it beyond the grave and a level playing field helps the next generation's individuals.

Andrew, why must you impose your narrow fact-based view of the world on the beauty of their assertions?

Next you'll be disputing the notion that liberals refuse to cut taxes despite knowing that cutting taxes increases tax receipts, just because liberals love increasing taxes.

d'd'd'dave - I almost always disagree with you, but your 8:55 comment - hear, hear. Clear & succinct.

Warren Terra, of course I'll dispute that.

Everyone knows that the Laffer Curve is the most empirically tested peer-reviewed napkin drawing evah!

When you inherit investments, your cost basis is the value at the time of inheritance, not the basis of the person you inherit from. All of the gains between the two are never subject to the capital gains tax.

They aren't subject to capital gains tax, but they are subject to the inheritance tax, which applies to the appreciated value rather than the original basis. If you have to pay inheritance tax on the full value, it makes sense to use that value as your basis.

Roger Moore, I don't really understand your comment. You appear to be asserting that inheritance tax should be levied at the market value of the assets rather than at their purchase price; that's fine, I would think that any reasonable person would agree with it (even opponents of the estate tax would probably agree with that being the best design of an estate tax, even as they want to see it abolished). But it's not really the point of J. Michael Neal's comment as I saw it.

J. Michael Neal's point, as I understood it, was that if the assets being inherited have never had their capital value realized during the lifetime of the deceased, then they will never have been subjected to capital gains taxes, because these are not assessed as part of the assets transferring from being the property of the deceased to being the basis of the estate. Thus, if someone makes a savvy investment decision long before the ends of their lives and never needed to actually sell their assets and realize their capital gains - for example if rather than selling their assets they simply borrowed against them - then when they die their heirs can inherit the assets (less, in the example, the loan with interest) with no capital gains taxes ever having been assessed - and, for most estates, also with no estate taxes being assessed. Ta-Dah, accumulated wealth that's never seen the tax man.

Now, I don't know how one would fairly address the issue J. Michael Neal raises (absent major transformations in our tax structure, such as a wealth tax), but I don't see how your comment really addressed J. Michael Neal's.

The big problem with trying to apply capital gains tax to inherited assets is trying to figure out what Grandpa's basis was for the stock you found in his safe deposit box. (A problem we will face with estates next year, unless they change the law, since they temporarily eliminated the basis step-up along with the inheritance tax for 2010).

It's hard enough to remember the basis for stuff I bought a long time ago - finding the basis for stuff that someone else bought who is no longer around to answer questions strikes me as a nightmare.

Roger Moore: Sure. If it is subject to the inheritance tax, then it is obviously taxed. My point was that everyone under that threshold gets stuff that isn't taxed. Thus, the people who get this tax break from the inheritance tax will get a lot of stuff that isn't ever taxed.

It's hard enough to remember the basis for stuff I bought a long time ago - finding the basis for stuff that someone else bought who is no longer around to answer questions strikes me as a nightmare.

Stock sales are registered. Someone has the information as to when it was purchased. Just use the market price on that date.

Both of my so-called progressive senators voted in favor of this lunacy. We in the great state of Washington are so ashamed.

All of you have my deepest apologies for their unconscionable behavior.

I wait for the day that something like the following is seriously proposed with the justification that it would incentivize people to get rich.
Money|Tax
10c | 90%
1$ | 80%
10$ | 70%
100$ | 60%
1000$ | 50$
10k$ | 40%
100k$ | 30%
1Mio | 20%
10Mio | 10%
100Mio | no taxes at all

Stock sales are registered. Someone has the information as to when it was purchased. Just use the market price on that date.

Not necessarily. First of all, you are assuming that all the companies involved are still in business and have accessible records going back far enough to cover the period of the transaction or transactions in question. That's a big assumption right there. Secondly, you are assuming that those records are adequate to establish a correct basis. That's an even bigger assumption.

Back in the 90's and early '00s, I was actively trading my then-employer's stock acquired through an ESPP and various option plans. Neither my employer nor my broker kept adequate records to establish the proper basis of the stock I was selling. If I hadn't kept track of all the transactions in my own Excel spreadsheet, and hassled the broker's assistant into faxing me the lot identifications that didn't appear on the confirmation slip, it would have been downright impossible for me to do my own taxes correctly. I shudder to think of a third party trying to reconstruct this after the fact without being able to consult me.

Things are a little bit better today. At least the broker's computer now tracks individual blocks of stock, and they even have the purchase dates and purchase price correct for the remaining blocks I own because I spent a bunch of time on the phone with them getting them to correct the information in their records once they came out with their new system. They still don't track the bargain element or AMT dual basis for option stock, both of which you may need for correct tax treatment when the stock is sold. But it's a lot better than they system they had in the 90s, when they didn't even try to match the lots you were selling against the lots you had bought.

Now this was a relatively simple example, involving only one company and one broker, which I mention because I know how screwed up the official records were. Now imagine that Grandpa's friend was awarded some stock from company A and reinvested the dividends in A's stock. Later A is acquired by company B, which later spun off company C. After other transactions involving B and C stock, the friend now gives some of his remaining stock in B to Grandpa, transferring it from friend's broker (D) to Grandpa's then broker E. Later, Grandpa takes delivery of a certificate from E, closes his account with E, holds the certificate for a while, pledges it as security for a margin loan at new broker F, and finally takes delivery of a new certificate from F, putting it in the safe deposit box where you find it after his death. If you want to calculate the proper capital gain on the stock without a basis step-up, you are going to need to trace that entire chain of transactions going back to the friend's original basis in A (gifted stock carries the basis of the original giver), keeping in mind that each broker probably doesn't know anything about the history of the stock before they get it (they probably just record that the stock was delivered to them on thus and such a date), company B only knows that the certificate was issued from some stock that broker F held in street name, and that you don't have any authority to access the friend's records, who is a stranger to you even if he is still alive. Presumably the friend told Grandpa what the basis of the gift was so he could use it on his taxes, and Grandpa may have written it down on a scrap of paper somewhere in a notation that made sense to him at the time. Good luck calculating the gain correctly.

The huge advantage of the basis step-up at death is that none of that prior history matters. For tax purposes, it's as if the stock was purchased by the estate on the day Grandpa died, and no one has to worry about trying to trace transactions they have no personal knowledge of.

well, envy and resentment are underrated.

Hartmut - we haven't gone that far, but there was a brief period in (IIRC) the late 80's when the marginal tax rate on the highest bracket was lower than that on the next highest.

This appears to have passed the Senate with only 51 votes. What happened to the auto-filibuster that the Senate operates under whenever it tries to do anything not favored by wingnuts? Or, to put it another way, who were the additional nine Democrats willing to vote for cloture on this thing?

yoyo.s comment. Also, many of the statistics presented in these discussions I find suspect. The notion that no small farms (farm businesses) have been forced to sell because of the cash requirements for estate taxes seems suspect since we know there have been repeated arguments over the decades for agricultural subsidies to save small farms.

I always smile when Hilzoy gets so so certain that the position being argued in the post is correct so all who disagree or have some different position must be wrong. What would be the position if we were a government that taxed and spent responsibly? It sounds as if the estate tax would be first on our list for Hilzoy.

The government has no rights except those granted by individuals. Individuals have rights.

Ben Alpers,

This bill, I think, went through the Budget Committee and bills that originate there are not subject to the filibuster/cloture process. (I think)

Also, many of the statistics presented in these discussions I find suspect. The notion that no small farms (farm businesses) have been forced to sell because of the cash requirements for estate taxes seems suspect

So, it seems suspect because it is at odd with your ideology, in spite of one of the biggest proponents for this myth admitting to the Times it could not cite a single example?

You then imply hilzoy is foolish for being 'certain' she is correct.

This high level of skepticism for presented evidence without an iota of data to dispute. Curious setting of the bar.

GoodOleBoy,

I should avoid posting before I've had my coffee. Of course this was passed via reconciliation, thus getting around the cloture requirement. Nevertheless, my sense is that there is a lot of discretion about what is allowed to be considered in this way. Could Reid and the Democratic leadership have put this up for consideration in another way?

Does not Hilzoy's certainty derive from ideology as well? And, I will accept your characterization as myth, so the subsidies should stop.

Andrew,

No implication of foolishness intended, only amusement that taking the products of others' labors is considered by some to be so right.

GOB, I didn't realize you were opposed to all taxation (since you apparently consider "taking the products of others' labors" wrong). Are you an anarchist, or do you have some other funding scheme in mind for the government?

Dave W makes sensible points about the difficulty of establishing the basis of inherited assets.

But that only argues for a simple rule, which need not be "Set the basis at the value as of the day of death." One could argue, with some justice, that the basis should be set to zero, at least for those assets which are not subject to estate taxes. Why not? After all, the new owner got them for free.

"The notion that no small farms (farm businesses) have been forced to sell because of the cash requirements for estate taxes seems suspect"

Once again, you believe in your imagination, instead of easily checkable facts. If you can find any evidence of people being forced to sell farms because of estate tax, get back to us. The voices in your head are not a substitute.

Meanwhile facts remain stubborn facts.

KCinDC,

I'm not an anarchist. I begin with the premise that the fruits of a person's labors belong to that person. Then I try to discern some intent from the founders of this nation which I believe was founded on principles not seen before or since in history and one of those principles is that our federal government is to be limited in its delegated responsibilities. We have not been very successful in limiting federal government powers and taxation is the principal means by which a government sustains and extends its power over the people. I'm supportive of taxation as a necessary component to support limited government but not for every possible function that someone could conceivably believe should be at the federal level to benefit the people. For a liberal democracy to succeed the government must have limits. We are now approaching a tipping point where less than a majority will pay all of our income taxes and my opinion is that bodes ill for the country's future. One of Hilzoy's arguments in the post is that tax cuts should go to those who will spend them if the purpose is to stimulate the economy, and I agree with that, but it is a mischaracterization to describe these redistributions as tax cuts when they go to people who have not paid any federal income taxes. Words have meaning. We look past each other sometimes when we are debating. This debate is over what powers the federal government should be exercising and not over principles related to taxation. Didn't the State of California suffer a reduction in its power over the people when constitutional limitations were imposed by the people?

it is a mischaracterization to describe these redistributions as tax cuts when they go to people who have not paid any federal income taxes

Federal income taxes are not the only taxes. Many, many people pay more in payroll taxes than they pay in income taxes. Those payroll taxes still are taxes, and every dollar paid in them is one less dollar to be spent on food, shelter, medical care, or other necessities.

Since you agree that income taxes are legitimate, I don't understand the point of your 11:03 comment. You agree that "taking the products of others' labors" is right. Your disagreement is apparently about how much taking is acceptable, not about whether the idea of taking is right.

This debate is over what powers the federal government should be exercising and not over principles related to taxation.

i don't buy it. i say the debate is simply over which party should control the government, and all these discussions about "the principal means by which a government sustains and extends its power over the people" are empty posturing for partisan gain. my my, what a bold accusation! how can i say such a thing? it's simple: i never once, in the 8 years the GOP was in control, heard anyone who supported the GOP say anything negative about or express concerns over the "powers the federal government should be exercising". but now that the GOP is out of power, suddenly so-called conservatives can't shout "limited government!" often enough. they're literally encouraging armed rebellion after spending 8 years shouting "traitor" at people who had questions about the actions of the GOP. they shrugged-off all spending increases under the GOP, but scream "socialism!" when someone else tries to spend, etc, etc. (you know the list). that tells me all those small/limited-government values are simply not at the core of their political philosophy; they don't care about it when their own party is in charge - at least not enough to endanger their own party's electoral chances. no, what they really care about is their own electoral fortunes. everything else is a means to that end.

the GOP really is the party of Limbaugh.

BYomtov: One could argue, with some justice, that the basis should be set to zero, at least for those assets which are not subject to estate taxes.

This (zero basis for inherited assets) is one of my preferred amendments to the estate tax, along with keeping the exemption at the current $3.5 million (and then adjust for inflation) and always keeping the rate at the highest ordinary income tax rate (which would lower it to 35% from 45% currently, but that seems fair to me, YMMV).

Note that I think there are provisions in the code for paying estate taxes over 10 years for certain small businesses (tho maybe only for family farms).

As someone who works in this field, I'd like to say that I agree with JMN and Dave W's explanations of the rationale for the step-up in basis for inherited assets.

One way to see this is to look at the difference in capital accounting for gifted vs. inerited assets.

In the case of gifted assets, the basis for the assets for the donee is carried over from that of the donor. Since the donor must be alive and competent enough to make legal gifts, there is some presumption that a party who is familiar with the acquisition of, and recent history, of the asset(s) can reasonably be expected to be provide cost basis information without too much of a burden.

However, no such presumption seems reasonable for inherited assets, since the deceased may have kept their financial affairs private, even from his or her closest relatives who are the natural heirs. Therefore, it is less reasonable to expect that heirs would be capable of reconstructing cost history for certain assets, including assets whose basis may have been adjusted many times by things like capital improvements and depreciation.

cleek,

I accept your description of the GOP and its behavior, especially recently. The GOP certainly has not reflected my conservative viewpoint. I don't think I have wasted any of my comments here defending the GOP.

KCinDC,

Your statement is correct but you need also to acknowledge that the payroll tax results from exactly the points we are arguing, namely, to fund programs that conservatives of my ilk would not support but Rooseveltian 'liberals' certainly would, since we have not yet any idea where their support for federal programs and spending would actually diminish.

The taking of private property is never right, but in the interest of having a limited government mainly to secure our individual rights, i and others concede an amount of authority to tax us to meet these needs, but it is not without limit.

"Does not Hilzoy's certainty derive from ideology as well?"

No, it derives from the Tax Policy Center.

One additional, overlong comment on cost basis for inherited assets:

Generally, if shares transfer from broker A to broker B, the new broker has no way to know any of the original basis data (date of initial purchase or price) of the asset. Since tens of thousands of accounts are transferred every day, the basis can't be known.

Suppose your uncle Lem bought ten shares of American Widget (AW) from Fred's brokerage in 1915. At that time, he'd have had the physical certificate for the stock. Lem died, and his son, cousin Ephus, inherited the shares. Ephus put the certificate in a drawer and forgot about it. He was drafted in WW2 and killed. (Sorry, but it helps the story along.) His mom and sister, cleaning out his room, found the cert. Fred's brokerage (remember?) went out of business in the depression, so Mom and Sis take the cert down to the local EF Hutton office and turn it in. Meanwhile American Widget has been bought and merged twice and the ten shares of AW are now 13.625 shares of International Widget & Clawhammers (IWC). See where this is going? And we're only up to about 1956 or so.

Now, the story is a bit silly on its face, **BUT STUFF LIKE THIS REALLY HAPPENS ALL THE TIME.** There's really no other reasonable way to handle cost basis than to value the asset at date of death, and use that date vs actual date of transfer to the heir(s) to determine the gain or loss.

There's really no other reasonable way to handle cost basis than to value the asset at date of death, and use that date vs actual date of transfer to the heir(s) to determine the gain or loss.

efgoldman,

As I commented above, while it's true that determining the actual basis is often difficult or impossible, that doesn't mean we need to have the step-up. It just means we need rules to set a basis when it can't be determined.

A zero basis is just one possibility, though it probably wouldn't be too onerous in the situation you describe. It's also possible to be more generous than that without just shrugging and using a full step-up. You could, for example use the actual basis if it is known, as it usually will be. Or you could use zero and apply a lower tax rate to the value at the time of death.

Bear in mind that assets whose purchase price is lost in the mists of history have accrued value, untaxed, for a long time. Suggesting that the heirs pay capital gains rates on the original purchase price, which is what a zero basis amounts to, as well as on the gain from a sale, does not strike me as wildly unfair.

While senatorial courtesy no doubt prevents any Senator from rising in response to Senator Lincoln and saying that she just said the dumbest thing ever heard in the Senate and is, in fact, working against her constituents' interests, perhaps someone could at least say that if the government tightened its belt in these times then the people of Arkansas would just suffer more and longer and that reinforcing economic ignorance will just make things worse in Arkansas and elsewhere. I have come to believe that no one should be able to graduate high school without an economics course (perhaps Secy Donovan can use some stimulus funds to encourage that), although it may still do no good. Another unfortunate emotion I get when I read these inane comments from some of our red state Dems(and all red state GOPers, of course) is that if government spending is so bad why do they keep taking all that extra money they get from the blue states. I would like some blue state senator (maybe Chuck Shumer) sometime to just propose an amendment to a budget resolution that we achieve buget balance by requiring any state that receives more from the federal govt than it sends in taxes to send back the excess. Surely all of the redstate GOP govs like Gov Sanford will want to do that since all that federal spending is just so bad. Now of course I dont believe that should happen but besides usefully pointing out the hypocrisy of these redstaters it might also point out how poorly the govts of these states serve their people in terms of public services. These states are always at the bottom of educational funding-just imagine what the schools of Mississippi, Louisiana, S Caroina, Arkansas, et al would be like without federal funding.

GOB,

Let's say that on a given day, two blocks of shares in XYZ Corp. get sold for the same price.

You sell 1000 shares XYZ at $10. You bought those shares 7 years ago at $5. You paid hard-earned, after-tax money for them.

I sell 1000 shares XYZ at $10. I inherited them from my uncle last week. My uncle had bought them at $5, also 7 years ago -- and obviously never sold them.

According to your own principles of fairness:
Should either of us pay a tax?
Should one of us pay more tax than the other?
If we both pay the same number of dollars in tax, does it matter what the name of the tax is?

--TP

"...reigning in wasteful government spending"

Inadvertent accuracy. Similar instance: The opening words of New York State's instructions for 2008 personal income tax returns:

What's NEW for 2008?
General Changes for 2008

Strengthened enforcement
To ensure that all taxpayers pay their fair share, the Tax Department is moving aggressively to further expand and strengthen its fraud-fighting capabilities, reign in evasion, and instill greater confidence in our tax system.

To me, it would instill greater confidence if they reigned openly, making it easier for them to be reined in.

Hlzoy, If you are interested in using estate tax reductions to spur spending, one solution would be to have a heavy estate tax, but have a higher threshold for untaxed gifts to family members prior to death.

If the 25 year old full time working grandson starts to get annual gifts of 20-30k some 10 years prior to the predicted death of his wealthy grandparents, he's much more likely to spend it, since he'll have an extra decade to do so. That could be quite useful to society.

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