Estate Tax Repeal: More Losers Than Winners · fresh start adjustment exempting gains accrued...

Estate Tax Repeal:More Losers Than Winners

By John Buckley

I. Introduction

In the past, the practice of law has been based on theunstated premise that Congress enacts laws with theintent that the new laws be part of a stable and semi-permanent legal structure. Attorneys then could plantheir clients’ affairs in reliance on that legal structure.

In many respects, that premise is no longer applicablefor lawyers practicing tax law. Since 2000, Congress hasenacted three major tax laws, the Economic Growth andTax Relief Reconciliation Act of 2001, the Jobs andGrowth Tax Relief Reconciliation Act of 2003, and theAmerican Jobs Creation Act of 2004 (P.L. 108-357). Each ofthose laws contain a myriad of budget gimmicks de-signed to reduce their officially scored revenue cost.Those gimmicks include delayed effective dates, longphase-ins, temporary provisions and the overall sunsetcontained in the 2001 act. As a result, tax practitioners arefaced with substantial uncertainty as to what will be thelaw in the future.1

Also, the deficits resulting from those tax reductionswill create enormous pressure for Congress to find ‘‘non-controversial’’ revenue increases in the future. Quiteoften, those ‘‘noncontroversial’’ revenue increases in-volve technical revisions to long-standing rules. Theprospect of those technical revisions to law is just onemore reason why tax practitioners will be faced with anincreasingly changing tax law.2

The effect of the uncertainty is probably the greatest inthe area of estate and gift taxation. As shown in thefollowing table (p. 834), major structural changes arebeing phased in and then terminated under current law.

Current law puts estate tax planners in an impossiblesituation. First, they need to know when their clients willdie to prepare a proper will or estate tax plan. Dependingon when the client dies, simple devices designed tomaximize the use of the estate tax exclusion could havedramatically different, and perhaps unintended, effects.Also, planners need to make an informed guess as towhat Congress might do in the future because virtuallyno one believes that the law, as currently written, willtake effect.

In the 108th Congress, the House of Representativespassed a bill that purported to make permanent the estatetax repeal that will take effect in 2010. The bill did notchange the provisions of law in effect before 2010. Itsimply removed the estate tax repeal from the effect ofthe overall sunset contained in the 2001 tax act. TheHouse-passed bill was not considered by the Senate anddied at the end of the 108th Congress.

As any casual observer would note, increasingly thereis nothing permanent about our tax laws. Legislationpurporting to make any tax benefit permanent is merelypromissory in nature because actions by one Congresscannot bind future Congresses. In many ways, legislationrepealing the 2001 tax act sunset merely changes thedefault rule, that is, what will happen in 2011 if there isno further congressional action. It would not eliminatethe possibility that a future Congress could reversecourse.

The retention of the gift tax was one of the mostsurprising and consequential aspects of the 2001 tax act.Without a gift tax, even a very short period during whichrepeal was in effect would effectively repeal the estate taxfor a generation. Individuals could simply gift the bulk oftheir assets to their children during the period of repeal.Retention of the gift tax effectively forecloses that oppor-tunity.

Regardless of what Congress does this year, whatactually occurs in 2011 and thereafter probably willdepend on two factors. The first is the overall budgetsituation. In that respect, the estate and gift tax issue willbe considered along with the other sunsetted tax reduc-tions. Foreign central banks may have the deciding voteon that issue because they have been the largest source ofmoney to finance our budget deficits in recent years.Second, repeal, with carryover basis, will disadvantagedramatically more estates than those benefited by repeal.That fact could have a dramatic impact on the ultimateresolution of whether estate and gift taxes will remainpart of our overall tax structure.

II. Budget SituationA detailed discussion of the federal budget outlook is

beyond the scope of this article. It is sufficient merely tonote that the budget projections are not favorable. Themost recent Congressional Budget Office projections

1The extent of temporary provisions is clearly set out by theJoint Committee on Taxation in ‘‘List of Expiring Federal TaxProvisions,’’ JCX-71-04, Doc 2004-24312, 2004 TNT 248-60, Dec.23, 2004. For example, 35 separate tax provisions terminate atthe end of 2005.

2See Joint Committee on Taxation, ‘‘Options to Improve TaxCompliance and Reform Tax Expenditures,’’ JCS-02-05, Doc2005-1714, 2005 TNT 18-18, Jan. 27, 2005. Practitioners can nowspeculate how many of the proposals outlined in more than 400pages may become law.

John Buckley is the chief Democratic tax counsel forthe House Ways and Means Committee. Aruna Kal-yanam also contributed to this article.

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show a fairly significant deterioration in the budgetprojections since the last projection in September 2004, adeterioration unrelated to the treatment of spending formilitary activities in Iraq and Afghanistan.3 The UnitedStates will continue to experience large deficits when thecosts of the war in Iraq, homeland security, and extend-ing temporary tax provisions are taken into account.There will be unprecedented general fund deficits thattemporarily will be masked by large surpluses in theSocial Security Trust Fund.

In the context of the overall budget numbers, the costof a permanent repeal of estate and gift taxes is small, butnot as insignificant as many have advertised. Permanentrepeal of estate and gift taxes would cost roughly $270billion over the next 10 years, even though it would notchange the law until the end of calendar year 2010. Moreinterestingly, the cost of making repeal permanent beginsto show up immediately, as the result of erosion in theincome tax base. The ultimate cost of repeal will begreater than the amount projected to be raised fromestate and gift taxes, again as a result of the erosion of theincome tax base. For example, in the last year of the

budget window, repeal would cost approximately $65billion, even though the tax itself is projected to raise only$58 billion that year.

III. Carryover BasisUnder current law, the cost basis of assets acquired

from a decedent is stepped up to the value of theproperty on the date of the decedent’s death.4 Thatstep-up in basis essentially eliminates the capital gainstax on increases in the value of property not realized in ataxable transaction before death. For depreciable prop-erty, the basis step-up is especially valuable. It eliminatesany depreciation recapture gain (which would otherwisebe taxed as ordinary income, or in the case of realproperty, at a 25 percent capital gains rate) and it permitsthe property to be depreciated again using the new basis.

The repeal of the estate tax that is scheduled to takeeffect in 2010 is accompanied by repeal of the currentstep-up in basis rule. Under the new rules, in general, thecost basis of property acquired from a decedent will bethe lower of the adjusted basis in the hands of thedecedent or the value of the property at death. The only

3The new projections show a deterioration of $500 billionover the next 10 years. See ‘‘The Budget and Economic Outlook:FY 2006-2015,’’ Congressional Budget Office, January 2005, p.xv.

4The executor may elect to value the estate on an alternatevaluation date, generally six months after the decedent’s death.If the election is made, the step-up is based on the value ofproperty on the alternate valuation date.

Scheduled Changes in Estate/Gift Tax

YearEffective

Exemption Top Tax Rate Gift Tax

Basis ofInheritedProperty

State Death TaxCredit

2004 $1.5 million. Ex-clusion for family-owned businessesrepealed.

48% $1 million Step-up in basis. 75% eliminated.

2005 $1.5 million 47% No furtherchange.

No change. Repealed. Re-placed with de-duction for statedeath taxes.

2006 $2 million 46% No furtherchange.

No change. No furtherchange.

2007-2008 $ 2 million 45% No furtherchange.


2009 $3.5 million 45% No furtherchange.


2010 Estate tax is re-pealed.

— Gift tax continues.Top gift tax rateequals top incometax rate (35%).Gift tax exclusionis $1 million.

Carryover basiswith $1.3 millionexclusion, addi-tional $3 millionfor transfers tosurviving spouse.

—

2011 and thereaf-ter

$1 million. Exclu-sion for family-owned businessrestored, creatinga $1.3 million ex-clusion when theestate includessuch property.

55% + 5% surtaxin some cases

Gift and estatetaxes become uni-fied again.

Step-up in basis. Restored to priorlaw.

C0MMENTARY / VIEWPOINTS

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exemption from a strict carryover basis regime is a $1.3million (an extra $3 million for transfers to survivingspouses) additional basis amount that the executor canallocate among the assets with unrealized appreciation.Generally, allocations of additional basis can be madeonly to the types of property that qualify for step-upunder current law (items like income in respect of adecedent and IRA, 401(k), and pension assets would notbe eligible).

This is not the first time that Congress enacted acarryover basis regime. A more complex version ofcarryover basis was enacted in 1976, delayed in 1978, andretroactively repealed in 1980. The 1976 version includedadjustments for federal and state inheritance taxes; afresh start adjustment exempting gains accrued beforeDecember 31, 1976; special exemptions for personal andhousehold effects; and a minimum basis amount with amandatory allocation among the assets in the estate.

A. Administrative IssuesOn the surface, the new carryover basis rules seem

simpler than the 1976 version. However, that apparentsimplification largely is only on the surface. In manyrespects, the new rules create as many problems as the1976 version — they are just different problems. There islittle question that the new rules will pose serious admin-istrative problems for estates.

1. Basis determinations. Obviously, any carryover basisregime requires a determination of the adjusted basis ofthe property in the hands of the decedent. The difficultyof making those determinations was one of the majorarguments against the carryover basis rules enacted in1976. That argument prevailed even though the 1976version contained several provisions designed to assist indetermining basis. It included a special exemption forpersonal and household effects and a fresh start adjust-ment equal to the property’s value at the end of 1976 sothat it was not necessary to look back to old records. Thenew version contains neither of those provisions.

Theoretically, individuals already are required to keeprecords of their basis for income tax purposes. However,‘‘many taxpayers have not maintained adequate recordsto meet the requirements of a carryover basis rule atdeath.’’5

It is doubtful that many people keep accurate recordsof the cost of their furniture, antiques, collectibles, orother personal effects. One large bank executor, reportingon its experience in attempting to comply with the 1976carryover basis rules, indicated that ‘‘the decedent’s basisfor personal effects was impossible to find in 70 percentof the estates, required time and research in 14 percent ofthe estates, and was available in only 16 percent of theestates.’’6

One would expect that the basis of financial assetswould be readily available. But even for those assets,basis records are incomplete in many circumstances andwould be difficult to construct.7 To determine the basis ofan investment in a real estate investment trust, a historyof the tax treatment of all distributions received by thedecedent is required. The basis of stock acquired throughstock splits or spinoffs requires knowledge of whetherthe transaction was accomplished in a taxable or nontax-able form. Dividend reinvestment plans in mutual fundsalso would require a history of the funds’ distributions.All of these records theoretically may be required, but‘‘many taxpayers simply have not maintained records forassets they planned to hold until death.’’8

Bank executors attempting to comply with the 1976carryover basis rules ‘‘were surprised by the extent of theproblems in determining the basis of marketable securi-ties.’’9 One large bank estimated that for approximately‘‘50 percent of marketable securities in the estates itadministered there were no clues other than the date ofthe stock certificates.’’10 The notion of stock certificates isfairly quaint today, so even that clue may not be availabletoday.

Current law recognizes the difficulty of having anyperson other than the taxpayer make determinations ofthe basis of property held by the taxpayer. Tax returnpreparers and tax professionals can simply rely on thetaxpayer’s statement of what is the adjusted basis ofproperty. They have no duty to inquire as to the accuracyof that statement.11 In the future, executors will not havethat luxury. They will have to determine the adjustedbases of the decedent’s assets and will be subject topenalties for negligent or deliberate errors.12

2. New reporting requirements. The new rules willplace burdensome reporting requirements on executors.The new reporting requirements, ‘‘if diligently followed,may prove even more burdensome for executors thanfiling estate tax returns.’’13 In the future executors will berequired to list the name and Social Security number ofevery heir, accurately describe each property, determinethe adjusted basis and fair market value at death of eachproperty, set forth the decedent’s holding period for eachproperty, provide information to determine whether gainfrom the sale of the property would be ordinary orcapital, set forth the allocation of additional basis to the

5‘‘Report on Reform of Federal Wealth Transfer Taxes,’’American Bar Association Task Force on Federal Wealth Trans-fer Taxes, Doc 2004-18577, 2004 TNT 183-19 (Sept. 20, 2004), p.33, hereafter cited as ‘‘ABA Task Force Report.’’

6H.R. Ways and Means Comm., Hearing on Carryover Basis,96th Cong. 81 (Nov. 13, 1979).

7See Joseph M. Dodge and Jay A. Soled, ‘‘Inflated Tax Basisand the Quarter-Trillion-Dollar Revenue Question,’’ Tax Notes,Jan. 24, 2005, p. 453, for a discussion of why many taxpayers donot know the basis of their financial assets. The article raises thequestion of how executors could possibly calculate the cost basisthat the decedents had in their investments if the taxpayersthemselves, while alive, could not do so.

8ABA Task Force Report, supra note 5 at p. 34.9H.R. Ways and Means Comm., Hearing on Carryover Basis,

96th Cong. 86 (Nov. 13, 1979).10Id.11Dodge and Soled, supra note 7 at 457.12See IRC section 6716.13Karen C. Burke and Grayson M.P. McCouch, ‘‘Estate Tax

Repeal: Through the Looking Glass,’’ Va. Tax. Rev. (Fall 2002), p.216.

COMMENTARY / VIEWPOINTS


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property, and provide whatever other information thesecretary may wish.14 Complying with those rules in anycircumstance would be quite daunting. Diligent compli-ance in the case of farms and other small businesseswould be extraordinarily difficult.15

The new burdensome reporting rules will have a fairlybroad reach. They will apply to all estates with property(other than cash) that has a value of more than $1.3million. They also will apply in any circumstance inwhich the decedent has received a gift (required to beincluded on a gift tax return) of property within threeyears of death and the property has unrealized apprecia-tion. Executors also would be well-advised to file thatreturn even when it is not required. The new carryoverbasis rules require that the allocation of the additionalbasis amounts be made on that return, leaving open thequestion of how estates that don’t file that return will betreated.3. Executors would face serious conflicts of interest.The 1976 version of carryover basis attempted to exemptsmall estates through a minimum basis rule. If the totaladjusted basis of the decedent’s property was less thanthat minimum amount, there was a mandatory allocationof the excess among the estate’s properties in proportionto the respective unrealized gains. That mandatory allo-cation was complex, and was dropped from the newversion, presumably because of that complexity. How-ever, the new allocation rule creates its own set ofproblems.

Under the new carryover basis rules, the executor hastotal discretion as to how to allocate the additional basisamounts among properties, avoiding the complexities ofthe 1976 mandatory allocation. However, the discretion-ary allocation poses ‘‘new dilemmas for executors indischarging their fiduciary obligations under state law. Inadministering a decedent’s estate, an executor owesfundamental duties to the decedent’s beneficiaries, in-cluding the duties of loyalty, care, and impartiality.’’16

Making distributions of property and allocations ofadditional basis amounts under the new rules will bevery difficult in light of the executor’s fiduciary duties.The executor could view his fiduciary duties as owed tothe heirs in the aggregate. In that case, the executorwould allocate the basis adjustments in a way to maxi-mize their value, that is, first to assets that would giverise to ordinary income. However, doing so would dis-advantage heirs receiving other property. Attempting toallocate the amounts in a way that provided equal taxbenefits would be extraordinarily complex.

Executors would be well advised to demand explicitinstructions in the will as to how to make the allocations.

They also would be foolish if they did not demand‘‘exoneration provisions in wills to shield them fromcomplaints by disappointed beneficiaries.’’17

The problems implicit with the new discretionaryallocation rules are best summarized as follows:

In sum, the executor’s broad discretion to allocatethe basis increases under the 2001 Act may wellprove even more cumbersome, time-consuming,and wasteful in terms of estate administration coststhan either the mandatory allocation formulas ofthe 1976 Act or the estate tax reporting require-ments of current law.18

4. Other technical issues. The ABA Task Force Reportdevotes almost 70 pages to a discussion of the problemsthat exist with the new carryover basis rules and possibleadministrative and legislative solutions. The problemsidentified in that report include the unequal treatment ofcapital losses,19 difficulty in applying basis adjustmentsto property sold during the administration of the estate,treatment of property with debt in excess of basis,treatment of installment notes, unequal treatment ofpension assets, administrative problems with allocationto spousal property, and discrimination in favor ofspouses in community property states (such as Texas andCalifornia) as compared to common law states. Even acursory examination of that report leads to a conclusionthat serious problems exist with the new rules and thattheir surface simplicity is quite misleading.

B. More Losers Than Winners From RepealIf one compares the benefits of estate tax repeal with

carryover basis to the alternative of simply extending thelaw in effect in 2009, there is no question that there will bevastly more losers than winners from estate tax repeal.

The JCT staff has estimated that approximately 15,100decedents in 2009 will have sufficient assets (that is,greater than $3.5 million) to be affected by the federalestate tax. Slightly over one-half of those estates will berequired to file an estate tax return but will have noliability for estate tax. Only the estates of approximately7,500 decedents would have estate tax liability, approxi-mately three-tenths of 1 percent of all individuals whowill die in 2009. It is worth repeating that only approxi-mately 7,500 estates will have sufficient assets to receiveany tax reduction from estate tax repeal. Another 7,600estates would receive no tax reduction but would nothave to file an estate tax return under a straight repeal.20

In contrast, the new carryover basis rules will affect allestates with noncash assets over $1.3 million. Approxi-mately 71,400 estates of individuals dying in 2009 willhave assets in excess of $1.3 million. There is no estimateof the number of estates to which the new basis rulesapply by reason of the decedent receiving gifts within

14See IRC section 6018(c).15Bank trustees reporting on their experience under the 1976

rules concluded that carryover basis presented difficult prob-lems for farms and ranches. Its application to equipment andother farm property proved virtually impossible in many cases.Anyone who ever witnessed a farm auction could understandthe difficulties. See H.R. Ways and Means Comm., Hearing onCarryover Basis, 96th Cong. 94 (Nov. 13, 1979), for examples ofthe problems.

16Burke and McCouch, supra note 12 at 221.

17Id. at 223.18Id.19Large estates with large unrealized capital gains would

receive tax benefits for unrealized losses. Smaller estates wouldnot. Estates without significant unrealized capital gains alsowould receive no benefit, regardless of size.

20See Appendix 1.



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three years of death. The number of estates affected bythe carryover basis rules could be almost five times thenumber of estates affected by the current system.21

Approximately 55,000 estates will receive no tax re-duction, nor exemption from a return requirement, byreason of repeal. But those estates will face a complexreturn requirement in the future, and some of them willface tax increases. Another 7,500 estates again will receiveno tax reduction from repeal, but will face a returnrequirement that is far more complicated than the onethat they are faced with under current law. Those estatesalso could face tax increases.

The question of exactly how many estates would facepotential tax increases under carryover basis that exceedthe tax reduction from repeal is far more difficult toanswer. Answering that question requires looking at twotypes of estates separately, those with surviving spousesand those without.1. Estates with surviving spouses. For estates with sur-viving spouses, repeal is almost always bad news. In2002, 42,856 estate tax returns were filed showing trans-fers to a surviving spouse.22 As a result of the maritaldeduction, only 4,021 of those returns showed any estatetax liability. Simply stated, approximately 90 percent ofall estates with a surviving spouse will receive no taxreduction from repeal. For those estates, repeal, at best,adds complexity.

There is a perception that very few estates withsurviving spouses would face tax increases under thecarryover basis rules because of the large ($3 million)additional basis adjustment provided for property trans-ferred to a surviving spouse. Some have suggested onlyextremely large estates (that is, those with assets withunrealized capital gains in excess of $4.3 million) wouldbe disadvantaged.23

However, the number of estates with survivingspouses disadvantaged by the new rules could be muchgreater than commonly perceived. The additional $3million basis amount can be allocated only to propertyactually passing to the surviving spouse.24 Property quiteoften is sold during the administration of the estate forreasons such as raising funds to pay administrativeexpenses or settle debts, sales of farm crops or otherproperty in the normal course of business, or when theestate is to be liquidated. The additional $3 million inbasis cannot be allocated to property sold by the estateeven if the surviving spouse is the sole beneficiary of theestate and would bear the burden of any tax on the sale.

That could be quite disadvantageous for estates withfarm or small business interests, where the survivingspouse does not intend to continue the business. In thatcircumstance, the interest in the small business couldonly receive a portion of the $1.3 million basic amount,even if the surviving spouse is the sole heir.

2. Estates without surviving spouses. Many estateswithout surviving spouses also will face actual tax in-creases under repeal. It is difficult to determine thenumber of those estates because there have been noprecise estimates of the portion of the value of propertypassing at death that is attributable to unrealized capitalgains. Most observers have suspected for a long time thatthere are substantial unrealized gains at death.

A study published in 2001 (the Poterba study) indi-cated that unrealized capital gains accounted for approxi-mately 36 percent of the value of property passing atdeath.25 The 36 percent figure obviously is an average.The Poterba study indicated that there is large variationin the amount of unrealized capital gains among estates.For example, approximately one-third of estates with netvalues (in 1998 dollars) between $1 million and $5 millionhave unrealized capital gains in excess of 50 percent ofassets. The study also indicated that the level of unreal-ized capital gains varies dramatically among assetclasses. For example, farm and other small-businessassets were estimated to be approximately 7 percent ofthe total value of property passing at death, but unreal-ized capital gains for that type of property were esti-mated to be approximately 16 percent of the total accruedgains. Farm and small-business assets were twice aslikely to have large unrealized capital gains as otherclasses of assets.

The Poterba study is not without flaws. It uses arelatively small sample and is not based on tax returninformation. Even with those flaws, congressional rev-enue estimates suggest that the Poterba study is fairlyaccurate but probably understates the amount of unreal-ized capital gains that exist at death.

In 2000 the CBO released revenue estimates on avariety of budget options.26 One of those revenue optionswas a proposal that would have taxed unrealized capitalgains at death. The proposal would have exempted gainson property passing to a surviving spouse or to charity,allowed use of the exclusion for gain on sale of aprincipal residence, and exempted small gains on per-sonal effects. The amount of property covered by theproposal is very close to the amount of property that willbe covered by the new carryover basis rules. The revenueestimate for the proposal would indicate that approxi-mately 42 percent of the value of property passing at

21This does not take into account the large number of estatesthat are not required to comply with the new return require-ment, but will do so in order to take advantage of the additionalbasis amounts.

22See IRS, Table 1 — Estate Tax Returns Filed in 2002: GrossEstate by Type of Property, Deductions, Taxable Estate, Estate Tax andTax Credits, by Size of Gross Estate, available at http://www.irs.gov/pub/irs-soi/02es01ge.pdf (2002).

23In 2002 there were over 1,700 nontaxable returns claimingthe marital deduction when the size of the estate was in excessof $5 million. Presumably there will be a much larger number in2009.

24ABA Task Force Report, supra note 5 at 73.

25James M. Poterba and Scott Weisbenner, ‘‘The Distribu-tional Burden of Taxing Estates and Unrealized Capital Gains atDeath,’’ in Rethinking Estate and Gift Taxation 422 (William G.Gale, James R. Hines Jr., and Joel Slemrod eds., BrookingsInstitution Press 2001).

26Congressional Budget Office, Budget Options, March 2000.



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death (outside of spousal and charitable transfers) con-sists of unrealized appreciation.27

Regardless of whether you used the Poterba figures orthe amount determined by using the CBO estimates,there is little question that there is substantial unrealizedappreciation at death and that many estates have signifi-cant levels of unrealized appreciation, quite often inexcess of 50 percent of assets.

For estates with significant unrealized gains (that is,greater than 50 percent), the potential tax increases fromcarryover basis will exceed the tax reduction from estatetax repeal over a fairly broad range of estates. Thefollowing charts compare the potential tax increases withthe benefits of repeal. The charts assume that the unreal-ized gains are taxed at a 15 percent capital gains rate, anassumption that understates the potential tax increases inmany circumstances. The charts also assume administra-tive expenses of $200,000. The charts show that the effectof the new carryover basis rules will be substantiallymore adverse in the case of estates with significantdebts.28

It is difficult to estimate how many estates would facepotential tax increases from repeal. However, the numberof estates with gross assets between $2.5 million and $5million, the levels where many will face tax increases,always has been much greater than the total number ofestates above $5 million.

But it is very easy to describe the type of estate thatwould be adversely affected. Estates of single individualsor previously married individuals for which there hasbeen a significant period of time since the death of thefirst spouse would be likely to have large gains, regard-less of the type of assets they hold.

Estates with farms, other active business assets, orrental real estate would be most likely to have largeunrealized gains. The basis of their assets would havebeen reduced by depreciation adjustments. Businesseslike farms typically have large amounts of ordinaryincome assets with low basis. Also, those estates arelikely to have significant levels of debt, with the resultthat their unrealized gains as a percentage of their netassets could be quite large.

3. Farm estates. Throughout the entire debate on theestate and gift tax issue, proponents of repeal have usedthe family farm as a primary example of who wouldbenefit from repeal. However, there is little question thatthe number of farm estates facing tax increases fromcarryover basis would exceed the number of farm estatesreceiving a benefit.

Farm estates would be among those most likely to beadversely affected by carryover basis rules. Farmers areable to use a cash method of accounting for income taxpurposes with the result that many of their assets, such asseed and supplies, have a zero basis. The crops growingin their fields have a zero income tax basis. Most live-stock has a zero basis. The ability to expense $100,000 peryear in equipment purchases also means that much oftheir equipment has a zero basis, but still could havesignificant value. Those low-basis assets are in addition

27The proposal was estimated to raise $10.5 billion in 2002,the first year in which it was in effect. The amount of theadditional tax at death was deductible for estate tax purposes.The Poterba study indicated that virtually all unrealized appre-ciation at death (outside of residences) occurred in estatessubject to the estate tax. Therefore, the amount of income taxraised by the proposal conservatively would have been around$14 billion, given the fact that the deduction for estate taxeswould have been worth approximately one-third of the grossincome tax raised. The capital gains rate at the time was 20percent, so, implicitly, the revenue estimate assumed approxi-mately $70 billion in unrealized gains. In 2002, the amount ofproperty shown on estate tax returns (net of the marital andcharitable deduction) was approximately $126 billion. Between2000 and 2002, the amount estimated to be raised from the estatetax declined by about 25 percent, reflecting the stock marketdecline. Adjusting the $70 billion figure to reflect the decline inthe baseline would mean approximately $53 billion of unreal-ized gains when compared to the $126 billion net figure,approximately 42 percent of assets passing at death.

28The tax increases start at $2.6 million, the point at whichthe unrealized appreciation will exceed $1.3 million. Theamount of the tax increases is 7.5 percent (the 15 percent capitalgains tax on one-half the assets) of each dollar over $2.6 millionuntil the estate is of a size that would have estate tax liabilityunder 2009 law. Then the increase is reduced by 37.5 percent ofthe assets in excess of that level, that is, the 45 percent estate taxrate minus the 7.5 percent additional tax under carryover basis.

Figure 1. Estates With No Debt

Size of Estate in Millions

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10,000

20,000

30,000

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2.6 2.875 3.15 3.425 3.7 3.81 3.92

Figure 2. Estates With 20 Percent Debt


Po

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20,000

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2.6 3.11 3.62 4.12 4.63 4.83 5.03



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to the unrealized appreciation in the value of their land.Those low-basis assets are often accompanied by signifi-cant debt levels.

Farm estates also are eligible for special benefits underthe current estate tax rules. They are entitled to specialvaluation rules that can reduce the value of their estate bya maximum of $840,000 currently. Also, farmers would bethe primary beneficiaries of the benefits for land subjectto conservation easements. Those benefits are in additionto the $3.5 million estate tax exclusion that would be ineffect in 2009. As a result of those benefits, the Depart-ment of Agriculture has estimated that approximately300 farm estates (approximately 1 percent of all farmestates) will face estate tax liability in 2009.29

The Agriculture Department also indicated that, basedon 2001 farm values, approximately 400 farm estateswould have unrealized capital gains exceeding thestep-up allowance under the new carryover basis rules.The bulk of those estates would have gross assets under$5 million, an amount that in most circumstances wouldnot result in estate tax liability under the 2009 law. Thatnumber will be dramatically higher in 2009 given in-creases in farm valuations. But even the vastly under-stated number of farm estates facing taxes under carry-over basis exceeds the number of farm estates facingestate taxes in 2009, using projected farm valuations in2009.

The Agriculture Department numbers make it clearthat there will be more losers than winners in the farmsector from estate tax repeal. The following table setsforth the wide asset range over which those tax increasescould occur.30

ConclusionThe uncertainty facing estate tax planners is large

because there is a wide range of potential outcomes to thedebate on estate and gift taxes. The current system couldbe retained, but with substantial changes. Congressmight simply extend the law in effect in 2009. It isconceivable that the budget pressures may force Con-gress to freeze the phase-in of the existing estate taxreductions at levels below what they would reach in2009. Finally, Congress could extend the repeal.

Estate tax planners who base their estate tax plans onrepeal must understand that repeal will benefit an ex-traordinarily small number of estates. Even many of the7,500 estates that would have estate tax liability with the2009 exemption level would face tax increases becausethe potential capital gains taxes from carryover basiscould exceed their estate tax liability. In contrast, the newcarryover basis rules will impose substantial complianceburdens on more than 71,000 estates per year. A signifi-cant number of those estates also will suffer tax increasesfrom carryover basis, even though they would receive nobenefit from repeal.

For the overwhelming percentage of estates (in excessof 99 percent), a simple extension of the law in effectduring 2009 would be the optimum result. They wouldcontinue to enjoy full step-up in basis, and have neitherestate tax liability nor any return requirement. The onlyquestion is whether their best interests will prevail in thecongressional debate.

Appendix

Congress of the United StatesJoint Committee on TaxationWashington, DC 20515-6453

Oct 18 2004

MEMORANDUM

TO: Janice Mays and John Buckley

FROM: George Yin

SUBJECT: Estimates of the Number of Returns Requiredto be Filed for Decedents Dying in 2009

This memorandum is in response to your request ofSeptember 22, 2004, for estimates relating to the numberof returns that will be required to be filed for decedentsdying during 2009. Your request asks that the estimatesbe specified as a percentage of the estimated number ofdecedents who will die during 2009. The Census Bureauestimates that approximately 2.5 million persons will dieduring 2009 in the United States. Your first question wasfor the percentage of decedents dying during 2009 thatwould have an estate tax liability. We estimate that theestates of approximately 7,500 persons who die during2009 will have an estate tax liability under present law, or

29Ron Durst, James Monke, and Douglas Maxwell, ‘‘HowWill the Phaseout of Federal Estate Taxes Effect Farmers?’’Agriculture Information Bulletin 751-02, U.S. Dept. of Agriculture(Feb. 2002).

30The table is based on the same assumptions and method-ology as the tables above. The only difference is it takes intoaccount the special farm valuation rules. The plateau in the tablereflects the fact that the special valuation rules affect basis undercurrent law.

Figure 3. Estates With 20 Percent DebtUsing Special Valuation


Pote

nti

al

Tax

Incr

ease

Fro

mR

epea

l

0

20,000

40,000

60,000

80,000

100,000

120,000

140,000

160,000

2.6 3.11 3.62 4.12 4.63 5.47 4.83 5.87



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roughly 0.3 percent of persons dying during 2009. Yoursecond question asks what percentage of persons dyingduring 2009 will have a requirement to file an estate taxreturn as the result of their gross estate being larger thanthe $3.5 million filing threshold. We estimate that theestates of approximately 15,100 persons dying during2009 will be required to file an estate tax return under

present law, or roughly 0.6 percent of persons dying inthat year. Your final question asks what percentage ofpersons dying during 2009 will have gross estates inexcess of $1.3 million. We estimate that approximately71,400 persons who die during 2009 will have estates thatwill be in excess of $1.3 million, or roughly 2.8 percent ofpersons dying during 2009.



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