Why is capital gains tax on inherited stocks calculated based on the value of the stock when inherited? [closed]

Question

Here in the US, my understanding is that if you inherit a stock, then eventually sell the stock, the capital gains tax is calculated as if you had bought the stock at the price that would have been its fair market value on the day you inherited it.

Assuming I'm understanding this correctly (and please correct me if I'm wrong), what would be the reason for this? It seems like an illogical and unfair tax advantage for the person inheriting the stock.

Is this just some kind of political deal that was made because of constituents' negative emotions about the so-called "death tax?" Or is there some kind of rational justification that I'm not understanding that is based on sound principles of economics or accounting?

Answer 1

You just inherited a stock. How much did the person who bought it pay for it? How would you know? But it's easy to determine how much the stock costs the day of the inheritance. It's a definite day that can be recovered from public records and allows specific rules to determine which price on that day. But you almost certainly don't know when the decedent purchased the stock much less the price that they paid for it.

If they don't mark to market, then everyone would be stuck trying to figure out how much their loved ones, who just died, paid for a stock. So on what may be one of the worst days of their lives, they have to try to drag through all the paperwork to try to find the price paid for a stock that was bought at some prior time so that they can perpetuate that information for some time, possibly years away, when they need it. And of course, they have to know that they will need the information.

Or a simpler way to look at it is that the one who inherited it has only seen a gain since the inheritance. Why would they pay tax on gains from before they obtained the stock? It would make more sense to charge the estate the tax on capital gains before that. They have as much of the information as possible then.

While it's easy to view any tax break as applying more to the rich, it's worth noting that the people who would have the most trouble finding these records are the middle class (it seems unlikely that the poor have many stocks, although they may have wealthier relatives). The rich, who can afford to pay people to keep their paperwork for them, are impacted less by arbitrary requirements. Their employees keep track of that for them, particularly immediately after a loss.

The middle class are far more likely to try to do their own paperwork. And because they've never done it previously, they tend to make mistakes and miss things.

Answer 2

The reason? As Pete noted, "Rich people write the tax code."

One can (and they do) argue about every bit of our tax structure. I live in a town where about 2/3 of our property tax goes to the school system. Zero kids, 1 kid, or 4, the property tax doesn't change. Fair? With my child off to college, I can move, or stay.

The tax code changes a bit over time. For estate tax, as far back as I recall, estates below the exemption amount (for 2018, $11.2M/person, up from $625K in 1998, when it first concerned me) benefit from no tax, and from the stepped up basis. The one exception was 2010, (when, as a Klingon would say "this is a good time to die) the tax itself was repealed, but there was no step up in basis. For the rich, this created an immediate windfall, but a paperwork burden for heirs that would extend until the asset was sold, or their own death.

The step-up is only one aspect of the estate tax discussion, it's not the only thing. Last year, at a $5.49M/person, fewer than 1 in 500 estates had any tax due at all. The doubling of the exemption makes it apply to far fewer.

It's fair to say that only the very rich would pay the tax, and of course only the even richer benefit from the cut, the increased exemption.