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There’s a basis battle brewing.
You’d be forgiven for missing it. After all, the arcane machinations of federal tax policy aren’t exactly the stuff of exciting dinner table conversation.
But, as the razor-thin Democratic majority looks at majorly upending the existing tax edifice, “basis” is the basis of a soon-to-be pitched battle.
The question arises in the context of the “estate tax,” or — depending on your lexical preferences — the “death tax.”
Here’s the general scenario, with numbers greatly simplified. Mr. Davis owns a sandwich shop, which he bought years ago for $100,000. It has grown by leaps and bounds. When he passes away, it is valued at $1 million.
If he had sold the business for the $1 million before he died, Mr. Davis would owe capital gains taxes on $900,000; the million less the $100,000.
If he passes away and leaves his business to his son, Davis Jr., then his estate pays tax on the $1 million, assuming his estate has a value greater than the current exemption. Under current law, if Davis Jr. decides to sell the business for $1 million after he receives it, he does not owe any additional taxes. That’s because of what is known as a step-up in basis, a technical term for adjusting the value of inherited assets to their value at the time of death.
President Joe Biden’s proposed tax changes would upend this structure. Mr. Davis’ estate would still owe estate taxes on his $1 million business (with the exemption caveat noted above). And then, Davis Jr. would owe income taxes on the $900,000 in capital gains, even if he didn’t sell the business.
If that sounds like double taxation, it is.
That is why many more moderate Democrats have opposed the president’s proposal. Particularly in the Midwest, family-owned farms and businesses could be crushed by this change. So, while Biden is aligned with the progressive wing of his party on this issue, it remains unlikely to pass.
Here’s the kicker. Biden isn’t totally wrong.
Obviously a lot of change has occurred in that time. General Motors and Exxon Mobil were the largest companies in the world by revenue. Walmart and Amazon hold those positions today.
Working backward from death is a viable, if morbid, approach to reconsider how Washington collects revenues. Eliminating the step-up in basis makes sense if the entire idea of the “estate tax” is scrapped. If people receive assets through an inheritance, tax them. But do it at the time they sell those assets like every other type of income, not when they inherit these assets, as the proposed tax law change would do.
This solves the “small business” and “family farm” problem. If the next generation keeps and runs the agricultural operation, they won’t need to pay death taxes. But, if they decide to cash out and sell to a housing developer, they will pay taxes on the income they earn.
As part of this reform, taxes should be aligned toward continued economic investment and growth. That is the exact approach taken in most Scandinavian countries, where business-level taxes are relatively low and personal taxes are high.
This idea hits some people wrong. Ethereal “businesses” can afford to pay taxes, so why not make them? If a rich person dies, why not take some share of their life’s work?
That is where politicians need to do some hard thinking. A gut reaction — like Biden’s elimination of the step-up in basis while retaining estate taxes — might feel good, but it doesn’t mean that it is a well-thought out policy.
In the words of Benjamin Franklin, the only certainties in life might be death and taxes. However, “death taxes” need not be certain. And the basis battle could be the right place to reconsider them.