We have discussed here many times the argument that the estate tax hurts family farms and small businesses, because the tax due allegedly forces liquidation of critical assets.
We agree that this did happen in some cases in the past, but that the current tax affects very few such entities today, and even when it does, there are options for payment plans and other accomodations. Nevertheless, for every one farm or business that was affected twenty years ago, we have an army of 100 phantoms who argue "you will be next" to families with a wealthy elder, making them easy prey for Republican arguments. How can we fight this phantom meme?
Currently, the estate tax values all assets at the date of death, then compares that to the exemption, then taxes the value past that exemption. IE, on an exemption of $2 million, an estate worth $2.5 million will be taxed on the $500,000 that exceeds the exemption, with the first $2 million tax free. However, the beneficiaries also get a stepped up basis value. So, if you inherited a $1.5 million house, and sold it for $1.5 million, you get to keep the money tax free. On the other hand, if it had been originally purchased for $100,000 and the owner had sold before death, he would've owed taxes on his $1.4 million gain.
So, what if we gave an estate a choice?
Let's say you're a rancher, inheriting a property that's been in the family forever. The original basis is $100,000 and the property is now valued at $6 million - if you wanted to sell. But you don't. You want to keep running cattle on it and enjoy it and live on it and work it as the family ranch.
So what if we let you choose between accepting the basis value of the property as $100,000 or as $6 million? If you're planning to keep it, the $100,000 basis keeps you well out of the way of the estate tax exemption. And since you're not planning to sell, the loss of the stepped up basis doesn't hurt you. If you do sell, say for $6 million, you'll owe capital gains tax on $5.9 million - just as if the previous owner had sold. If you are planning to sell, you'd take the basis at $6 million, pay the estate tax, and owe nothing further when it sold.
I like this because it gives people a choice - and makes the full tax implications of a transfer at death more clear. For people who really are family farmers and family business owners, it shelters them beautifully from tax. People who really are hoping for the money and who are using the farmers as a smokescreen will pay the tax. The government gets their money eventually - perhaps not for decades - but on a timeline the owners control.
Can this work?