Pres. Clinton's proposal to repeal sec. 1014(b)(6) is unfair.

Under current law, property acquired from a decedent generally is assigned a new basis equal to the property's fair market value (FMV) on the date of the decedent's death. In common-law (i.e., noncommunity property) states, property jointly owned by husband and wife at the time the first spouse dies is treated as half owned by the decedent and half-owned by the surviving spouse. Therefore, the surviving spouse receives a stepped-up basis only in the decedent's half of the property that passes to the surviving spouse; the half treated as owned by the surviving spouse is not eligible for a stepped-up basis at the first spouse's death.

In community property states, each spouse also is treated as owning half the community property. However, under Sec. I 014(b) (6), the surviving spouse is entitled to a stepped-up basis for both portions of the property. Thus, there appears to be potentially inconsistent treatment under present law.

Administration's Budget Proposal for FY 2001

The Clinton Administration is proposing to repeal Sec. 1014(b)(6), eliminating the stepped-up basis in the portion of community property owned by the surviving spouse before the decedent's death. Only the portion of community property that passes from the decedent would continue to receive a stepped-up basis.

This proposal would be effective for decedents dying after the date of enactment. The Administration made the same proposal for FY 2000.

Summary of Congressional Joint Committee on Taxation's Staff Analysis

The stepped-up basis for community property was enacted in 1948. As stated in S. Rept. No. 80-1013, 80th Cong., 2d Sess., (1948) p. 26, "the usual case was that practically all the wealth of the married couple was the property of the husband." For example, if a husband died first, having owned "practically all the wealth," the surviving spouse would have had a stepped-up basis in most of the property, because most of it would have passed from the decedent to the surviving spouse by bequest or inheritance.

However, in a community property state, a surviving spouse is deemed to own half the community property; consequently, the surviving spouse's half interest in community property could not pass to the surviving spouse by bequest or inheritance. Only the decedent's half interest would have passed to the surviving spouse from the decedent; therefore, only half the property was eligible for a stepped-up basis.

Sec. 1041(b)(6), which provides a stepped-up basis for the surviving spouse's half of property, was intended to equalize the two treatments and "give persons receiving community property the same basis for determining gain or loss on a sale of property after death as is given recipients of property passing under the common law" in that "the surviving spouse's interest in community property shall be deemed to have been acquired by bequest, devise, or inheritance from the decedent."

The Clinton Administration's position is that changes to the Federal estate tax treatment of jointly held property in 1981 have undermined the premises on which Sec. 1014(b)(6) is based. For example, under Sec. 2040(b), half the value of any property held by a decedent and his spouse as tenants by the entirety or as joint tenants with right of survivorship (when the decedent and spouse are the only joint tenants) is included in the gross estate of the first spouse to die, regardless of the source of the consideration for the property. As a result, the decedent's part of the jointly held property is eligible for a stepped-up basis, but the other half is not.

Observation: The 1981 "Blue Book" (p. 234) stated the following "Reasons for Change" regarding jointly held property:

The Congress believed that rules governing the taxation of jointly held property between spouses were unnecessarily complex. In particular, the Congress recognized that it is often difficult, as between spouses, to determine the amount of consideration that each spouse provided for the acquisition and improvement of their jointly held property....

In view of the unlimited marital deduction adopted by the Act, the taxation of jointly held property between spouses will be relevant only for determining the basis of property to the survivor.... Accordingly, the Congress believed it appropriate to adopt an easily administered rule under which each spouse is considered to own one-half of jointly held property, regardless of which spouse furnished the original consideration.

The Administration's proposal would eliminate the (apparent potential) inconsistent treatment among decedents in community property and common-law states, by disallowing the stepped-up basis for property that never passed from a decedent to a surviving spouse in community property states.

Under present law, separate property of one spouse receives similar treatment in common-law states and community property states. Property that was owned 100% by a decedent, and that passes to a surviving spouse, would be eligible for a stepped-up basis in the entire property (because it was included in the decedent's estate), even if no tax is due. Similarly, if property were owned 100% by the surviving spouse, there would be no stepped-up basis; the property would not have passed from the decedent.

The procedures for converting community property to separate property could be difficult in some states. Under the Administration proposal, community property would be treated less generously than nonjointly held property in common-law states when the property was owned by the first spouse to die.

Comment

The Administration's proposal would restore the pre-1948 inequality that existed between community property and common-law states: Married couples must treat community property as 50% owned by each spouse, while married couples in common-law states can arrange for their property to be 100% owned by the older spouse (increasing the likelihood that the entire property will be included in the estate of the first spouse to die). If such property is passed to the surviving spouse, a 100% stepped-up basis will be achieved, even though no estate tax will be imposed on this property on the deceased spouse's death. Therefore, fairness dictates no change to current law.

An alternative would be extending Sec. 1014(b)(6) treatment to surviving spouses in common-law states. However, this approach might encounter government resistance, because it could be perceived as a "revenue loser."

The Joint Committee on Taxation and approximately 40 members of the California Society of CPAs have protested the Administration's proposal to appropriate Congressional and Treasury Department officials. Readers in other community property states should also voice their opinions to these Federal decisionmakers.

FROM STUART R. JOSEPHS, CPA, TAX ASSISTANCE PRACTICE (TAP), SAN DIEGO, CA