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Rounding error #1
The simplest change would be to end basis step-up at death, eliminating the “Angel of Death” loophole. Eliminating basis step-up for heirs would result in a regime called “carryover basis.” The basis of an asset would not change when bequests are made. When the asset is later sold by an heir, the taxable basis would be the same as when the decedent owned it. Under a carryover basis system, capital gains tax would continue to be owed when the gain is realized. An asset that was purchased at $100, bequeathed and inherited at $300, and sold by the heir at $350 would have a capital gain of $250. Under the current system with step-up in basis, the capital gain would only be $50.
Shifting to carryover basis discourages lock-in and tax shelters. The Joint Committee on Taxation staff calculate that a policy ending basis step-up implemented this year would raise $104.9 billion over the next 10 years. In addition, curtailing tax avoidance would allow policymakers to raise the capital gains tax rate and generate increased revenues, without generating as much tax avoidance as would occur with a higher rate under the current system.
A carryover basis regime maintains the practice of taxing capital gains at realization and thus retains the advantages related to investor liquidity and ease of valuation.
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