In November of 2014, I wrote a blog entitled Income Tax Basis Adjustment of Trust Assets at Death of Trustor. The blog discussed how under long-standing tax law, an asset of a decedent or of the decedent’s revocable trust or estate receives a new basis for income tax gain and loss purposes equal to the value of asset as of the date of death of the decedent. For example, if the decedent or the decedent’s revocable trust died owning Apple stock with a value of $115.00 per share on the date of death, if and when the stock was sold by the trust or its beneficiaries any taxable gain is equal to the excess of the sale price over $115.00 per share. This is true even though the decedent may have purchased the stock at $90.00 per share during his or her lifetime, and $90.00 per share was the decedent’s basis in the asset. As noted by Attorney Collins Hunsaker in his recent blog entitled President Obama’s Tax Plan and the “Trust Fund Loophole”, President Obama wants to eliminate this income tax basis adjustment of an asset to the value on the date of death, and instead require that the income tax basis remain the decedent’s basis even after death. Mr. Obama touted this in his most recent State of the Union Speech, and labeled it the closing of the “trust fund loophole”. If such a proposal was enacted into law, if and when the stock was sold by the trust or its beneficiaries in the above example, any taxable gain would be equal to the excess of the sale price over $90.00 per share, the decedent’s basis, and not the $115.00 per share, the value as of the date of death.
So what is unfair about that? After all, that is what the decedent’s income tax basis was when he or she was alive. Why should the beneficiaries obtain an increase in the income tax basis to the value on the date of death just because a death occurred? The answer is federal estate tax. When one dies, the decedent’s estate and trust is potentially subject to federal estate tax depending on the value of the estate and trust assets. If federal estate tax is due as a result of the death of the decedent, the tax rate is 40% and generally the tax must be paid within 9 months of the date of death. Federal estate tax is based on the value of the assets as of the date of death, not the decedent’s basis in the assets. Accordingly, to subject the decedent’s estate, trust and beneficiaries to federal estate tax based on the value of the assets as of the date of death, it is only consistent from a tax point of view to adjust the asset basis to the same value for income tax purposes if and when the asset is sold, namely the value of the asset on the date of death. To do otherwise has traditionally been viewed as unfair and inconsistent. As opposed to closing the “trust fund loophole”, arguably the adoption of such a proposal would allow the government “to have its cake and eat it too” tax-wise.