Greenville Estate Lawyer: “Estate Tax Red Herring #2”
December 22, 2009
The next anti-estate tax argument that you may hear is that the estate tax taxes assets that have been taxed already. While this may be true in some instances, it is false when appreciated assets are considered.
To understand this requires attention to the interplay between income taxes and estate taxes. For the rest of this discussion an equation must be remembered. The equation is unrealized gain = current fair market value – tax basis. Onward and upward to an example.
Assume “A” purchased a home in 1965 for a total purchase price of 100k. “A” passes away in 2009 and that house is now worth 4 million. In this example “A’s” tax basis is the cost of acquiring the assets, or 100k, and “A” had an unrealized taxable gain of 3.9 million dollars that has never been subject to income tax. Under 2009 estate tax law, there will never be an income tax payable on this gain because upon “A’s” death the tax basis becomes the date of death value of the asset. This is known as stepped up basis. The basis becomes 4 million dollars and if the house is sold for 4 million, the taxable gain is zero.
On the estate tax side, taking into account the current 3.5 million dollar exemption, the taxable estate would only be 500k. As a result, under year 2009 estate tax laws, 3.4 million of the 3.9 million gain would be completely untaxed at the federal level. This current regime seems quite generous to me, and disproves the argument that the estate tax taxes assets twice.
Another example may help to hammer this point home. Assume “A” purchased the home again in 1965 but this time for 50k dollars. Assume “A” dies in 2009 still owning the home and that the home is valued on the date of death at 450k dollars.
In this example you have a 400k dollar unrealized gain. With the 2009 estate tax exemption, there is zero estate tax owed. If the home is sold after death for 450k dollars, there is no income tax owing because of the stepped up basis. That’s right, you still get a stepped up basis, even if no estate tax is payable. In this second example, a 400k dollar gain has completely escaped the income tax and the estate tax. Again, this strikes me as quite generous. You have a gain which has gone untaxed at the federal level.
If somebody tells you with certainty that the estate tax taxes people twice, you are now armed to debate this claim. The above examples were limited to real property assets, but the same argument works for any appreciated asset, such as stocks, bonds, collectibles, furniture, furnishings, art work,etc. Anybody who decries the estate tax as double taxation is either being willfully deceptive or does not understand the interplay between the federal income tax and the federal estate tax. In a time where serious people are worried that the United States is on the verge of bankruptcy, I believe that those arguing against taxes should present better arguments than this.
If you want to know the havoc that the year 2010 estate tax law is going to have on income tax basis, stay tuned.