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An Estate Tax Twist

Wednesday, April 13, 2005; Page A16

AS THEY DEBATE today whether to repeal the estate tax, House members should think about this: Repeal may actually hurt more family farmers and small businesses than it would help. And for many other people with big but not supersized estates, repeal would add cumbersome and costly new reporting requirements -- and could force them to pay more taxes, not less, than they would owe if the tax were frozen at the level it is slated to be in 2009.

Here's why. The plan to do away with the estate tax is paired with the kind of arcane adjustment that gets little notice during debate and then turns out to have big consequences. The change has to do with the way the value of inherited assets is calculated. Currently, heirs who inherit property -- anything from houses to stocks to jewelry to equipment -- don't have to worry about how much it originally cost or whether it was depreciated along the way. Rather, the property is valued as of the time of its inheritance; in tax talk, it has a stepped-up basis. So, for example, stock holdings that are sold by heirs aren't subject to capital gains taxes stretching back to the original purchase.

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But a change inserted into the 2001 tax bill -- in part to keep the price tag down -- would modify this. Under the new rule, heirs who receive property worth more than $1.3 million total (surviving spouses get an extra $3 million cushion) would have to value the assets the same way as the original owner; this is what's called carry-over basis. While they wouldn't owe any estate tax, they could have to pay sizable capital gains taxes when the assets are sold.

As a matter of pure tax theory, this change might make sense. But in the real world it would be enormously difficult to administer; after all, the person who knows the original price of the asset is dead. Even for assets not being sold, there will be bills from lawyers and accountants for figuring out the proper valuation for estates worth over $1.3 million. According to estimates by the Joint Tax Committee, 55,000 estates won't get any extra tax benefit as a result of eliminating the estate tax but will have to file these complicated new accountings. Just what the country needs: a tax code that's even more burdensome and complex. By contrast, leaving the estate tax at its 2009 level, in which the first $3.5 million of every estate is exempt from taxation and the basis rule is left unchanged, would avoid this widespread hassle -- and, as we noted yesterday, still shield 99.7 percent of estates from tax.

In a magnificently ironic twist, this change could hit the very people estate tax repeal is supposed to help: family farmers and small-business owners. Farms, for example, tend to have land that's appreciated enormously and equipment that's been depreciated but that still has significant value. If the heirs hold on to the farm the valuation change won't have a big effect. But if they sell, as many do, their tax bill under "repeal" could easily end up being bigger than if the estate tax had been left in place. The Agriculture Department estimates that about 300 farm estates would have to pay estate taxes in 2009 but that (even based on farm values in 2001) about 400 farm estates would have unrealized capital gains greater than the $1.3 million exclusion. Lawmakers: Imagine what you're going to hear from your constituents if you do them this favor.

© 2005 The Washington Post Company