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Romney-Bennet Plan to Curb Stepped-Up Basis May Be a Step Too Far

Posted on Dec. 17, 2019

A bipartisan tax plan from a pair of senators that calls for ditching stepped-up basis at death in favor of carryover basis would precipitate a major shift in estate tax planning.

“Carryover basis — assuming that it ever becomes both legally and politically permanent, which is a big assumption — would certainly upset some long-standing premises of wealth planning,” Austin Bramwell of Milbank LLP told Tax Notes.

The plan, announced December 15 by Sen. Mitt Romney, R-Utah, and Senate Finance Committee member Michael F. Bennet, D-Colo., proposes replacing stepped-up basis with a substantial exemption of $1.6 million for individuals and $3.7 million for married couples.

The provision is short on details but is listed as a revenue raiser to pay for other tax initiatives, including technical fixes to the Tax Cuts and Jobs Act and an expanded child tax credit.

Cover Your Assets

The modus operandi of tax planning for wealthy estates today is for individuals to transfer high-basis assets out of their estates and to die holding low-basis assets, the latter to maximize the tax savings from getting the step-up in basis and wiping out the accrued capital gains tax-free.

“That type of planning may no longer be attractive in a world of carryover basis,” Bramwell said. “By contrast, strategies for deferring recognition of gains, such as charitable remainder trusts, will become more attractive.”

Howard M. Zaritsky, a retired attorney and frequent lecturer on estate tax planning topics, said the question of where wealthy taxpayers would want to allocate basis under a carryover regime “is actually both simple and difficult” to answer.

The simple approach is to “pick the assets that will generate the highest tax when sold,” Zaritsky said, pointing to property that doesn’t qualify for capital gains treatment upon sale, like business inventory, annuities, and assets with depreciation recapture. If none of those are an option, the taxpayer would choose assets like collectibles, which have the highest capital gains tax rate applied when sold.

However, things become more complicated as the taxpayer is forced to consider when to sell the asset. “You want to allocate basis to assets that will be sold relatively soon, so that you get the benefit of the basis sooner,” but often it is simply unknown when that will happen, Zaritsky said.

Business inventory can reasonably be expected to be sold fairly quickly at ordinary income rates, “so that is a good choice,” Zaritsky explained. But an art collection that stays in a family for generations isn’t the best choice for applying the exemption.

Eliminating basis step-ups at death could also lead to more tax planning with irrevocable trusts, according to Steve Gorin of Thompson Coburn LLP. Shifting assets into irrevocable trusts has the disadvantage of losing the basis step-up at death, so under the Romney-Bennet plan, “moving assets to irrevocable trusts is incentivized a little bit more,” he said.

Bramwell further noted that from a practical perspective, wealth planners would need to advise their clients to keep careful records for their heirs, and testamentary tools may need to be revised to ensure that the full spousal basis amount is used.

A Better Way?

The Romney-Bennet tax plan may not be perfect, but even the glimmer of bipartisan support for eliminating or scaling back the step-up in basis is encouraging, Eric Toder of the Urban-Brookings Tax Policy Center said.

“The exemption is larger than I would prefer, but it is a start,” Toder told Tax Notes.

That exemption would substantially reduce the amount of revenue gained, but even the revenue from just the wealthiest taxpayers would still be significant, Toder said. And the one-time lifetime exemption that kicks in only when estates are being transferred would go a long way toward minimizing the administrative challenges, he added.

However, Bramwell expressed concern that Romney and Bennet are aiming to revive an ineffective and cumbersome “sprinkle basis” system, like the one briefly effectuated in 2010, in which the executor of an estate can “sprinkle additional basis onto certain property passing from a decedent.”

“It did not work that well,” Bramwell said. He added that to revive it now would require substantially more estates to appraise a decedent’s assets and “comply with the inevitably onerous reporting requirements that go with it.”

Bramwell’s preferred solution would be to give all estates a specific amount of exclusion, and then allow any unused exclusion to be distributed to beneficiaries, similar to how an estate’s unused net operating losses are treated under section 642(h), or used up by the estate electing to recognize gain under section 643(e).

Likewise, Zaritsky observed that carryover basis has already been tried twice, yet still never made permanent, a key problem being that it’s often “incredibly difficult to determine the basis of assets.”

Zaritsky noted, however, that Canada has imposed capital gains taxes at death for several decades now, “and they do not seem to have problems figuring out a decedent’s basis.”

Just how difficult it would be depends in large part on how the bill is drafted. For example, when the Obama administration proposed repealing stepped-up basis, it called for making death a realization event, with carryover basis limited to transfers to a spouse or gifts to charity. That proposal also called for exempting all gains on personal property, such as household furnishings, and allowing a modest $100,000-per-individual exemption on other types of capital gains.

“The devil is always in the details,” Zaritsky said.

Follow Jonathan Curry (@jtcurry005) on Twitter for real-time updates.

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