Since I started practice, there have been repetitive proposals
to change the step-up basis rules upon death. With some exceptions, the general
rule is that assets at one’s death take fair market value as their tax basis.
EXAMPLE: A decedent purchased his principal residence in 1975 for $56,000. The house is in Brentwood, Tennessee, and upon death the property is worth $1 million. The property’s tax basis is reset from $56 thousand to $1 million. Sell it for $1 million shortly after death and there is no gain or loss.
The common exception are retirement accounts: 401(k)s,
403(b)s, traditional IRAs and so on. These assets do not reset to fair market
value (the tax nerds call this the “mark”), as the Code wants distributions
from these accounts to be taxed as ordinary income.
There is a downside to the mark, of course. If the
asset has gone down in value, then that lower value becomes the new basis.
The proposals I to which I refer would require
carryover basis for the asset, meaning that tax basis will be acquisition cost
plus improvements with no reference to market value at death.
I get it, I really do.
Why should income tax basis for an asset be marked
just because someone died?
To continue that line of argument, why should there be
a mark if one did not even have to file an estate tax return, much less pay
estate taxes? The lifetime exemption in 2024 is $13.61 million. That is
rarified air. So few estate tax returns are being filed that the IRS has been
reassigning estate examiners to other functions.
The flip side asks how many times an asset is going to
be taxed. To require carryover basis is to extend taxation on someone even
beyond their death, which – I admit – seems macabre.
I prefer the mark over carryover basis for a different
reason:
I am a practitioner and have been for decades. The argument for carryover basis may sound reasonable in the insulated confines of academe or expense account restaurants in corridors of power, but one should make a reality check with practitioners who have to work with these rules.
I expect that many if not most practitioners have
encountered assets that are nearly impossible to cost or – if possible –
possible only with extraordinary effort.
We had an example during busy season. A client and his
siblings sold undeveloped land inherited from their grandfather and great aunt.
The property had been owned separately, then as tenants in common, had survived
two deaths and eventually found its way into a trust. The trust had terminated,
and the siblings had formed a partnership in its place. One of the siblings was
convinced that the basis for the land was incorrect. It was possible, as we had
assumed the tax work from another accountant. We had not previously questioned the
basis for the land. No one had.
It took weeks and multiple people investigating and researching
the provenance of the land. Even so, we were fortunate to research only back to
the dates of the two deaths, as those would be the trigger dates for any
potential mark.
This is but one asset. One taxpayer. One practitioner.
Who knows how many times the story repeats?
There is also a dark side to establishing tax basis
that should be said out loud.
Let’s look at the Youngquist case.
Dean Youngquist (DY) did not file a tax return for
1996. He in fact had not filed a tax return since the late 1980s, which is a
story for another day.
DY started day trading in 1996. He opened an account
with Protrade. He closed that account in December 1996 and opened an account with
Datek, another brokerage.
Do you remember the 1099-Bs that brokerages send you
and the IRS? The Protrade and Datek 1099-Bs totaled $2,052,688 in sales
proceeds.
COMMENT: I expect to see net trading losses, as net gains from day trading are uncommon.
The IRS send DY a tax assessment of $791,200, with another
$796,726 in penalties and interest.
DY had been space-tripping, I guess. He did not file a
tax return. He did not remember receiving notice(s) from the IRS. He had no
idea that liens were filed on his property. He was shocked to learn that the
IRS wanted to sell stuff to collect his taxes.
COMMENT: DY needs to tighten his game.
DY asked how the IRS got to the $791 grand in tax, much
less the penalties and interest.
Easy, said the IRS. Since you did not provide records,
we used zero (-0-) as your basis in the trades.
Folks, we all know there is zero chance that DY had no
cost in his trades. The world does not work that way. How then did the IRS
assert its position with a straight face?
Here is the Court:
The fact that basis may be difficult to establish does not relieve a taxpayer from his burden.”
DY did not even file a tax return, so it appears he
put zero effort into discharging his burden.
If the taxpayer fails to satisfy the burden, the basis is deemed to be zero.”
Harsh, but that is the Coloman decision and extant
tax law.
What did DY do next?
Believe it or not, he found – way, way after the fact
– records for his Datek account.
The United States will abate the assessments by the portion of the assessments, penalties, and interest that were based upon the $601,612.50 in stock sales through Datek in 1996.”
Datek, BTW, was not his major trading account. Protrade
was.
… there is no evidence documenting Youngquist’s actual stock transactions in the Protrade account. There are no statements from Protrade. There are no letters or emails from Protrade. Youngquist did not keep any notes about the stocks he purchased and sold, and he is unable to testify from memory about the specific stocks he bought and sold.”
DY had waited too long. Protrade was out of business.
DY had an idea:
· He
started his Protrade account with $73,000.
· He
closed his account with $67,333.
· There
was an aggregate loss of $5,677.
Seems reasonable.
Here is the Court:
First, I can find no authority to support his aggregate theory of proving basis in stock.”
This is technically correct, as each sale is its own
event. Still, I would urge the Court to pull back the camera and use common
sense. In legal-speak, we would call this an equity argument.
His only evidence is his own uncorroborated testimony. Youngquist’s bank account records do not reveal the November 5, 1996 withdrawal went to Protrade. There is no wire transfer record. There is no cancelled check evidencing payment to Protrade. Youngquist relies solely on his own testimony to suggest these facts.”
Personally, I believe that DY lost money overall in his
Protrade account, but that is not the issue. The issue is that he needed to
retain (some) records and file a return, responsibilities which he ignored. He
then wanted the Court to do his work for him, and the Court was having none of
that.
A taxpayer’s self-serving declaration is generally not a sufficient substitute for records.”
DY won on Datek but lost on Protrade. This was going
to be expensive.
Back to the carryover basis proposal.
DY could not find records in 2013 going back to 1996.
Granted, that is a long time, but that is nothing compared to requiring records
from other people, possibly from other states and likely from decades earlier. There should be a concession in tax
administration that ordinary people pursuing ordinary goals are not going to maintain
(and retain) records to the standards of the National Archive, at least not in
overwhelming numbers. Combine that with a possible Youngquist body slam to zero,
and the carryover basis proposal strikes as economically inefficient, financially
brutish, possibly condescending, and an administrative nightmare. Why are we
discussing a tax policy that cannot survive exposure to the real world?
Our case this time was U.S. v Youngquist,
3:11-cv-06113-PK, District Oregon.
