Belligerati

To see what is at stake, consider how differently this year’s and last year’s regimes treat the same asset held by two fictional widows: Ms. Bentley has total assets of $20 million, while Ms. Subaru’s total is $2 million. Each owns a $110,000 block of the same stock bought for $10,000 years ago. This simplified example uses a block of stock, but its logic applies to all appreciated assets, including houses and land.

Under current law Ms. Bentley and her heirs prosper. If she dies this year and the stock is sold, her heirs will owe only a $15,000 capital-gains tax, whereas last year the same move would have incurred nearly $50,000 in estate tax. By contrast, Ms. Subaru’s heirs would have owed nothing last year because the estate was below the $3.5 million exemption. This year they would owe the same $15,000 capital-gains tax Ms. Bentley’s heirs do.

The reason: Under the old estate tax, assets could be written up to their full value at the death of the owner, and neither widow had to pay capital-gains tax on the $100,000 increase in the stock last year. But current law fully taxes gains while imposing no tax on estates. Quite simply, the demise of the 45% estate tax helps Ms. Bentley and her heirs more than the 15% tax on appreciation hurts them. For Ms. Subaru, the reverse is true.

Why No Estate Tax Could Be a Killer

I would prefer a system where death is not a be a taxable event but it does not save you anything in taxes either. In such a system any assets you hold when you die go to your heirs who would then have the same cost basis that you do. That is, you bought an investment for a $100 and are selling it for a $1000, so you’ll owe taxes on the that $900 difference when you sell. If you die, your heirs get the investment and when they sell it for $2000 5 years later, they owe taxes on the $1900. It is a bit unclear from the text above, but I believe the policy change has been implemented to be in line with my preferences.

So in the old system, people with smaller estates could get a step up basis on the investments they inherit, so in the example, they’d pay taxes only on $1000 five years from now. People with larger estates pay inheritance taxes but not capital gains on the $1000.  The tax changes appear to have eliminated the step up basis but also the inheritance tax, which seems more equitable and also more efficient. The two examples are for large estates, one of them huge, so I have no idea if the changes have trickled down to smaller estates but it would be more fair if they did. A broad based tax system is subject to less business cycle variation in revenue and allows lower rates. Lower rates make compliance more likely by lowering incentives to work extra-legally around taxes as well as avoid spending legal and financial resources to minimize payments legally.