President Bush’s plan for permanent repeal of the estate tax is being promoted as a boon to farmers and owners of small businesses. But the bill actually is something of a Trojan horse – containing a “stepped-up cost basis” provision that will cost thousands of heirs more in capital gains taxes than they would pay under less expensive reform plans offered by a Kansas congressman.
Imagine your parents bought a 5,000-acre farm for $500,000 in 1950 and it was worth $5 million when they died. Under the old rules, the farm’s value would be “stepped up” to the full $5 million within six months of their death. If the heirs later sold it for $6 million, they would pay capital gains tax on just the $1 million increase in value that occurred while they owned it.
In contrast, the estate tax repeal (House Resolution 8) passed by the House of Representatives would value the farm at its original cost of $500,000 at the owners’ death. If the heirs sold it for $6 million, they’d owe capital gains tax on $5.5 million.
This formula applies to any capital gains, including stocks – which could impose a staggering burden for heirs who might not have the paperwork from their parents’ purchases of stocks over many years.
Most of us needn’t worry much about the estate tax revision, because both current law and the plan now pending in the Senate provide a $1.3 million capital gains exemption for heirs and a $3 million exemption for a spouse. Using the above example, the farmer with a $4.5 million capital gain could have passed $3 million of it to his spouse at his death and the remaining $1.5 million to his children. The children could deduct their $1.3 million exemption and pay tax on just the remaining $200,000 – about $30,000 at the 15 percent federal rate, plus any state taxes. When the wife died, her heirs would receive another $1.3 million exemption, along with a tax bill of $255,000 on the remaining $1.7 million in capital gains.
But the heirs in our example would have paid no tax at all if a competing plan proposed by Rep. Dennis Moore, D-Kan., had passed. Moore would have raised the current estate tax exemption of $1.5 million to $3.5 million for individuals and $7 million for a couple. That would effectively repeal the tax for 99.7 percent of all estates in the U.S. – while costing the Treasury far less than the $290 billion over 10 years estimated in the Bush plan. And the Moore plan did not include the Trojan horse provision that would force many Americans to pay for their estate tax “repeal” with sharply higher capital gains taxes.
The Senate gets the next crack at this contentious issue.
