Taxing Unrealized Appreciation On Lifetime Transfers And At Dying – Tax

A. Background

The Biden administration will propose a change in the tax-free
basis step-up at death which has been a part of the tax law for a
long period of time. Carter Ledyard’s first relationship with
this subject occurred in 1970 when Richard B. Covey was contacted
by the Trust Division of the American Bankers Association. In the
Tax Reform Act of 1969, changes were made in the trust income tax
laws relating to accumulation distributions and an unlimited
throwback rule was enacted. The ABA determined that it needed
outside help for modifying the newly passed throwback rules. In
addition, the ABA felt it needed help concerning changes in the
transfer tax laws which, because of a lack of time, were not
included in the 1969 Tax Act and would be dealt with later. One of
those changes was in the tax-free step-up in basis at death (the
“Basis Increase”). Covey was retained as special tax
counsel for the Trust Division, a status which continued until
around 2000. In the 1976 Tax Reform Act, the Basis Increase was
changed to carryover basis but before its effective date, Congress
repealed this change and continued the Basis Increase.

On April 28, 2021, the Biden administration released a fact
sheet describing the American Families Plan. It states:

End capital income tax breaks and other loopholes for
the very top
. The President’s tax reform will end one
of the most unfair aspects of our tax system: that the tax rate the
wealthy pay on capital gains and dividends is less than the tax
rate that many middle-class families pay on their wages. Households
making over $1 million – the top 0.3 percent of all households –
will pay the same 39.6 percent rate on all their income, equalizing
the rate paid on investment returns and wages. Moreover, the
President would eliminate the loophole that allows the wealthiest
Americans to entirely escape tax on their wealth by passing it down
to heirs. Today, our tax laws allow these accumulated gains to be
passed down across generations untaxed, exacerbating inequality.
The President’s plan will close this loophole, ending the
practice of “stepping-up” the basis for gains in excess
of $1 million ($2.5 million per couple when combined with existing
real estate exemptions) and making sure the gains are taxed if the
property is not donated to charity. The reform will be designed
with protections so that family-owned businesses and farms will not
have to pay taxes when given to heirs who continue to run the
business. Without these changes, billions in capital income would
continue to escape taxation entirely.

The fact sheet does not mention other transfer tax changes such
as reducing the exemptions and curtailing the use of zeroed-out

B. Gutman Article – Introduction

An article by Harry L. Gutman captioned “Taxing Gains
at Death” was published in the January 11, 2021 issue of
Tax Notes Federal (the “Gutman Article”). On May 12,
2021, at a meeting of the Select Revenue Measures Subcommittee of
the House Ways and Means Committee on Funding Our Nation’s
Priorities: Reforming the Tax Code’s Advantageous Treatment of
the Wealthy, Gutman was one of several witnesses. His testimony was
based upon his prior article referred to. He is a former Deputy Tax
Legislative Counsel in the Treasury Office of Tax Policy from 1977
to 1980 and was later Chief of Staff of the Joint Committee on
Taxation from 1991 to 1993. The Article contends that the basis
step-up at death should be repealed and replaced by a policy in
which death and lifetime transfers are income tax realization
and/or recognition events (the “Appreciation Tax”). The
Article is comprehensive, well-written and covers many, but not
all, of the issues which would arise under the system he proposes
(the “Gutman Proposal”). Knowledgeable people thought
that the Gutman Proposal was a forecast of what the Biden
administration would recommend.

When we decided the main subject of this issue, the results of
the Georgia Senate races were in and the Senate was in a 50/50
division with the Democratic Vice President to resolve any tie
votes. President Biden had indicated his decision to repeal the
step-up in basis for a decedent’s assets and his desire to make
changes in the treatment of capital gains. Therefore, a discussion
of the Gutman Proposal seemed an appropriate subject.

Subsequent events confirmed that decision but “muddied the
waters” because of Democratic proposals for changes in the tax
laws. First, President Biden’s position on infrastructure
included social programs supported by progressives in significant
amounts. Second, proposals in both the Senate and House included a
change which broadened the elimination of the step-up in basis to
include a periodic taxation of appreciation in trust assets but not
in entities which could achieve purposes similar to those by
trusts. Also, Chairman Wyden of the Senate Finance Committee
announced that he was going to file a bill later this year which
would accomplish the purpose of marking-to-market assets held by
individuals and entities.

Several major concessions are made in the Gutman Article. First,
a deduction would be allowed against the estate tax for the
Appreciation Tax paid. This is not really a concession, but rather
a “fairness” point. Without it, the total taxes at death,
federal and state, could exceed 80 percent of some estates. Second,
assets currently owned would be exempt from the tax. Stated another
way, only assets acquired after the effective date would be subject
to tax. The second item contrasts with another approach which would
subject to tax assets currently owned but only appreciation
accruing after the effective date (a “fresh start”
approach). The Article states that a liberal transition rule is
necessary to gain adequate political support for the Proposal and,
in a section captioned “Inadequate transition relief,”

Transition has proven to be a particularly difficult issue.
There is no agreement on whether the regime should apply to all
realizations occurring after the effective date, only appreciation
occurring after the effective date, or assets acquired after the
effective date. As detailed later, each option has a different
effect. Ideally, transition should not create winners and losers.
But sometimes the search for equitable transition rules produces
perceived inadequate relief or political impracticality and, as a
consequence, a desirable law change is not enacted. In my view, we
should not let the perfect be the enemy of the good. The most
important objective is the enactment of the general rule;
transition relief is, by definition, temporary.

Gutman makes a “political” judgment that without the
exemption, passage of an appreciation tax would be unlikely.
Whether that judgment is correct in the current fiscal and
political climate is unclear. The opposite concern is that the rule
would not be accepted by progressives, who are the strongest
supporters of taxing appreciation upon death and may oppose even a
fresh start.

Another concession relates to proof of basis problems. The
Gutman Proposal says:

2. Lack of basis records. Whether one finds
credible the claim that basis records somehow disappear at death
(recall that they were necessary to establish gain or loss on a
lifetime sale), the proposed system would put taxpayers on notice
prospectively of the need for basis records, and it would provide
relief for problematic asset areas – namely, personal residences
and noncollectible tangible personal property. Also, a lookback
rule would be provided to determine unknown basis. Under that rule,
the basis of an asset could be determined by discounting its value
at the relevant tax date back to its acquisition date.

Of course, if the acquisition date was also unknown, the relief
would be ineffective. The problem of proof is particularly
significant with respect to elderly persons who are now in their
80s and 90s.

C. Objectives of Gutman Proposal and Our

The Gutman Proposal states:

The challenge is to design a system that is comprehensive in
coverage, administrable, perceived as fair, and not subject to
abuse. The task involves not only identifying the assets that would
be subject to the regime but also the exclusions and exemptions
deemed necessary to promote administrability and perceptions of
fairness. One must resolve the fundamental question of what
constitutes the taxable unit to which the new regime would apply.
The need for and design of antiabuse protections must be examined.
Further, provisions to assist in valuation problems and the
determination of unknown basis must be devised. And finally, one
must select an effective date provision that will be viewed as
acceptable by the affected community of taxpayers and advisers. The
proposal reflects my judgment on the appropriate balance of
conceptual purity, administrability, and political reality.

In summary, we believe the Gutman Proposal needs changes in
respects discussed below.

D. Discussion of Details of Gutman

A fundamental departure from past proposals would exempt
nonmarketable property held at death from immediate taxation. The
gain on a nonmarketable asset would be “realized” but not
“recognized” at death. The tax due would be calculated,
but payment deferred until the asset was disposed of by the
decedent’s estate or by the owner who inherits it during the
owner’s life. Interest would be charged on the tax for the
deferral period. This deferral would not apply to lifetime

Life insurance would be exempt from the Appreciation Tax but
Gutman notes that internal interest buildup on permanent life
insurance should be taxed to the policyholder. A $250,000 exclusion
would apply to gain on a principal residence. See IRC Sec. 121. The
exclusion would be portable for transfers to a surviving spouse.
Thus, for spouses, the exclusion would be $500,000. All nonbusiness
tangible personal property (other than collectibles as defined in
IRC Sec. 408(m)(2)), would be exempt from tax. Transfers to charity
would also be exempt. An alternate valuation date similar to IRC
Sec. 2032 would apply. On another subject, the present gift tax
interest exclusion in IRC Sec. 2503(b) would be repealed, thus
ending the exemption for property subject to powers of

As to marital transfers, the Article states:

Unless recognition was elected, all transfers to a surviving
spouse in any form that would qualify for the estate tax marital
deduction would be treated as realization-but-nonrecognition events
in accordance with the rules governing outright transfers of
nonmarketable property. The effect would be to determine the tax
due for all property held by the decedent but defer the tax on
appreciated property transferred to a surviving spouse until the
earlier of the sale of the property, the inter vivos
transfer of the property (whether marketable or not), the death of
the surviving spouse in the case of marketable property, or the
taxable disposition of nonmarketable property in the hands of a
testamentary distributee of the surviving spouse. Immediate
recognition could be elected for loss property.

Payment of the tax and interest would be deferred until the last
of the events referred to in the quotation. This result contrasts
with what occurs with transfers in trust where deferral could be
extended through several transfers. See the discussion below under
the heading “Transfers in trust.” A simpler and fairer
alternative would be to apply the Appreciation Tax upon the
surviving spouse’s death or earlier disposition and providing
for carryover basis on the first death for spousal assets.

The Article summarizes the overall approach as follows:

Subject to specified exclusions and exemptions, all deathtime
and lifetime transfers would be income tax realization events. All
non-spousal deathtime transfers of marketable assets20
would be recognition events. All non-spousal lifetime transfers
would be recognition events. Recognition could be elected by the
taxpayer-transferor for any realized gain on an asset-by-asset
basis. The tax on realized but unrecognized gain, together with a
deferral charge to equate the total payment to what would have been
due upon realization, would be payable when the subject property is
later disposed of in a recognition event.

20Marketable securities are defined in Section 731(c).
Actively traded personal property, as defined in reg. section
1.1092(d)-2, would also be subject to recognition.

The use of the cross-reference to IRC Sec. 731(c), part of the
income tax partnership provisions, to define “marketable
assets” and to distinguish them from non-marketable assets
without further explanation is unfortunate. Many members of the
Trusts and Estates bar, an important constituency in winning
approval for the Proposal, will not be conversant with these
provisions. We will provide further explanation later in this

In dealing with the administrative problems of the Appreciation
Tax discussed later, they will be simplified by having assets
either “in” or “out” of the system instead of
having each asset partly in and partly out.

President Biden has suggested that for taxpayers with more than
$400,000 of income, ordinary income tax rates would apply to
capital gains. His Press Secretary has clarified that the $400,000
figure covers families and not individuals. He has not gotten into
the details of “closing the loophole” step-up basis at
death. One of those details is providing a period of time for
updating estate plans to address the change in the law.

The Gutman Article discusses the treatment of nonmarketable
property and comments upon the transfer of such an asset, including
multiple nonrecognition transfers such as where A dies and
transfers property to B which is followed by the death of B and the
distribution of the property to C. The tax computed at A’s
death would not be changed by B’s death (even if assets had
declined in value). Any additional tax at B’s death would be
imposed on the difference between the value of the property at
B’s death and B’s basis of the property determined by
reference to the value of the property upon A’s death. If C
disposes of the property during life, he would be responsible for
the payment of deferred taxes and interest on both the transfer
from A to B and the transfer from B to C. This may be illustrated
by the transfer of a farm (presumably a nonmarketable asset) with A
dying and transferring the farm to B, his son, and B then dying and
transferring the property to C, a son of B. C sells the farm. At
A’s death, the transfer of the property to B would not be
taxable. At B’s death, the transfer of the property to C would
also be nontaxable and would include both the increase in value at
A’s death and any further increase in value at B’s death.
Upon C’s sale, the taxes deferred at A’s death and B’s
death, plus interest, would be payable, as would the
“regular” tax on C’s sale, with C’s basis based
on the value of the farm at B’s death.

Interest would be payable commencing with the transfer from A to
B and from B to C. The Article does not discuss whether interest
payable is deductible by any person owing the interest.

In a letter To the Editor of Tax Notes Federal posted on June 1,
2021 captioned “Farmers: The ‘Gains at Death’
Liquidity Issue is a Straw Man,” Gutman said:

Members of Congress from both sides of the aisle as well as
numerous commentators have expressed concern about the impact on
family farms and closely held businesses of treating death as an
income tax recognition event. They are correct.

Treating death as an income tax recognition event requires the
valuation of the affected asset, identification of its basis, and
calculation and payment of the tax due. While these requirements do
not generally pose significant issues for marketable property, they
raise legitimate concerns for nonmarketable property. And in the
case of business property, including both farms and closely held
businesses, the most acute problem is finding the funds to pay the
tax. Forcing a sale of some portion of the business interest,
borrowing to secure the funds to pay the tax, or providing for
payment of the tax in installments is not an acceptable solution.
The following addresses the problem directly.

We first divide the world into marketable and nonmarketable
assets. The latter category includes ALL nonmarketable assets – not
just farms and closely held businesses. The liquidity problem is
not restricted to them, and a broader category eliminates messy
design questions in determining the characteristics of the entity
entitled to relief. In all cases, there will be exclusions for
noncollectible tangible personal property and some level of net

For marketable property, the tax is due and payable at death.
For nonmarketable property, the first (and my preferred) option
would be to calculate the tax due at death but defer its payment
until the subject property is sold. The taxable event would not
turn upon material participation in the enterprise by a family
member, but rather would occur upon the identifiable event of sale.
In an ideal world, that deferred tax payment would bear interest at
a rate designed to make the present value of the deferred payment
equal to the tax that would have been paid at death. Thus, from the
perspective of horizontal equity, these interests would not receive
favorable treatment when compared with marketable assets for which
the tax is payable immediately. A second-best solution would be to
omit the interest charge and simply defer the tax. One must
recognize, however, that this solution would treat this class of
assets more favorably than marketable assets (and would provide
significant incentives to transform marketable assets into
nonmarketable assets). In addition, if this recognition route is
chosen, it would be possible to provide that the value of the
affected property could be determined under the special use
valuation provisions of the estate tax, thus establishing the value
of property at its actual rather than “highest and best”
use. This would be of particular importance to farms.

A distinctly less favorable alternative would be to simply
provide a carryover basis for nonmarketable property, thus
deferring the calculation and payment of the tax until the property
is sold.

Here is the takeaway: Any of the forgoing eliminates tax
liability at death. The tax payment is deferred until funds are
available from a sale of the affected property. The liquidity straw
man is eliminated.

E. Level of Taxation

The attached table in Appendix A compares the total estate tax
and Appreciation Tax on three New York estates. Each estate has a
value of $50 million. One estate has no appreciation, a second
consists entirely of appreciation and the third consists of 50
percent appreciation. The assumptions on rates are beneath the
table. As noted, the computation of the Appreciation Tax assumes
the stated Biden proposal for ordinary income rates on part of the
capital gain. If the estate is in the top brackets, a dollar of
appreciation results in about 20 cents of additional total tax as
compared to a dollar that is not appreciation.

The comment is often made that “people should pay their
‘fair share'”. Is such an increase “fair”?
The Proposal does not discuss the appropriate rate of combined
taxation on transfers of property. An Appreciation Tax would be a
new level of taxation in addition to the current levels which
consist of gift tax, estate tax, generation-skipping tax and
corresponding state taxes. We do not believe an appreciation tax
would be fair unless the basis of capital assets is indexed for

Any tax payable upon death and paid would be deductible from a
decedent’s gross estate. Deferred tax paid upon a sale by the
executor should be made deductible for estate tax purposes as an
administration expense by an amendment to IRC Sec. 2053. Deferred
tax not paid during estate administration is not a liability of the
estate and is payable by the owner of the property when it is
disposed of in a taxable transaction. Since the value of property
that passes to a recipient is reduced by the deferred tax
liability, the deferred tax should reduce the value of the asset in
the recipient’s estate. However, this does not reduce estate
tax in the first estate.

F. Offsetting Gains and Losses

1. Transfers at Death

a. General Rules

A decedent’s marketable assets may have an overall net gain,
which is “recognized” and subject to the Appreciation
Tax, and nonmarketable assets which have an overall
“realized” net loss. Does the net loss on nonmarketable
assets offset the net gain on marketable assets, reducing the net
gain that is subject to the Appreciation Tax? In the converse case,
where marketable assets have a net loss and nonmarketable assets a
net gain, does the net loss offset the net gain, reducing the
realized gain that determines the deferred tax on nonmarketable
assets? The answer is yes, which it should be if the goal is to
produce the same result as if all the assets had been sold
immediately prior to death.

The Article states:

Net recognized gain, determined after accounting for any net
realized loss from nonmarketable property, would be taxed
separately from all other income realized during the decedent’s
final tax year, at the rate then applicable to capital gain. The
gain would be spread over five years, so the effect of progressive
rates would be moderated. A net recognized loss would first be
used, on a pro rata basis, to offset net realized gain from
nonmarketable property held at death. Any remaining loss may be
used to offset net capital gain on the decedent’s final income
tax return, and to the extent necessary, may be carried back to the
three preceding tax years. Losses in excess of net capital gain for
the preceding three years may be used to offset ordinary income
commencing in the year immediately preceding death. (footnote

Does the five-year “spread” refer to payment in five
annual installments or to an income averaging computation? Based on
language elsewhere in the Article, it means averaging.

A net recognized loss on marketable property that exceeds net
realized gain on nonmarketable property can be used on the
decedent’s income tax returns as described in the quotation. Is
the converse true? The paragraph quoted above could be read to say
that a net loss on nonmarketable property that exceeds the net gain
on marketable property cannot be used on an income tax return.
However, the issue is clarified in a subsequent paragraph which

Realized losses in excess of realized gains on nonmarketable
property (net realized losses) could be used to offset net
recognized gain, with any excess treated in the same manner as net
losses on marketable property.

This is the correct result. The ability to use an overall excess
loss on the decedent’s income tax returns should not turn on
whether the excess is attributable to marketable or nonmarketable
assets. If both marketable and nonmarketable assets have a net
loss, the combined excess loss should be usable in the same manner
as an excess loss attributable to one group of assets.

To the extent an excess loss is unusable on the decedent’s
income tax returns in the way described above, the unused amount
could be used to increase the basis of some, or perhaps all, loss
assets, pro rata, by the amount of the unused loss. The calculation
of an adjusted basis for the affected assets would be complex,
disrupting one of the simple aspects of the Proposal, that an
asset’s post-death basis is its value for estate tax

The application of these rules to spousal transfers raises an
issue. If a spousal transfer includes marketable property, a third
category of property is introduced: marketable assets that are
treated on the decedent’s death in the same manner as
nonmarketable assets, but will be treated as marketable assets upon
the surviving spouse’s death. A simple and seemingly correct
approach is to treat these marketable assets as nonmarketable
assets on the first spouse’s death in applying the rules
discussed above in this section.

b. Election to Recognize Gain or

At several points, the Proposal refers to an election to treat a
realized gain as a recognized gain, and (less clearly) to treat a
realized loss as a recognized loss:

. . . unless immediate recognition is elected, the tax due for
illiquid nonmarketable property would be deferred until that
property is sold. Part I(C)(1).

Recognition could be elected by the taxpayer-transferor for any
realized gain on an asset-by-asset basis. Part I(E).

The transferor of any nonmarketable asset may elect recognition
treatment on an asset-by-asset basis. Part II(A)(3).

. . . I propose that the immediate recognition of gain be
limited to marketable assets other than those transferred to a
surviving spouse (and for which recognition is not elected) . . .
Part II(A)(2)

Unless recognition was elected, all transfers to a surviving
spouse in any form that would qualify for the estate tax marital
deduction would be treated as realization-but-nonrecognition events
in accordance with the rules governing outright transfers of
nonmarketable property . . . Immediate recognition could be elected
for loss property. Part II(A)(5).

As noted, the recognition rules are referred to piecemeal in the
Article, and no examples are given. A consolidated statement of the
recognition rules with examples is needed. Apparently, however, for
transfers at death it is possible, on an asset-by-asset basis, to
elect to recognize a gain or a loss that would otherwise only be
realized. In some cases, the rules permitting a net loss in one
category of assets to be offset against a net gain in the other
will eliminate the incentive for an election to recognize gain or
loss, but this will not always be the case.

For example, suppose the estate has two marketable assets, each
with a built-in $100 gain, and two nonmarketable assets, each with
a built-in $100 loss. The net recognized gain of $200 is offset by
the net realized loss of $200. The Appreciation Tax payable at
death is zero and there is no deferred tax. No election is needed.
However, if one of the nonmarketable assets instead has a $100
built in gain, the net realized loss is zero, and no portion of the
$200 recognized gain is offset. If an election can be made to
recognize the loss on the $100 loss asset, recognized gain is
reduced to $100. Of course, this must be reflected in the
calculation of the deferred taxable amount, which after the
election should be based solely on the nonmarketable asset with a
$100 gain. As a result of the election, the Appreciation Tax
immediately due will be reduced, but deferred tax will be
correspondingly increased.

2. Transfers During Life

The Article states:

The guiding principle of this proposal is that, to the extent
practicable and consistent with other applicable income tax rules,
all transfers of property should be accounted for in the tax return
of the transferor at the time of the transfer. Consequently, apart
from interspousal transfers, charitable transfers, and transfers of
nonbusiness tangible personal property (other than collectibles),
all gratuitous lifetime transfers would be recognition events.
Recognition (rather than realization) is appropriate because the
lifetime transfer is a voluntary event, and liquidity issues can be
anticipated and resolved. An election to treat interspousal
transfers as recognition events is provided in the proposal.

A threshold question is what is meant by “all transfers of
property should be accounted for in the tax return of the
transferor at the time of the transfer?” Apparently it means
that gains and losses on lifetime transfers are not, as with
transfers at death, the subject of a separate calculation of the
Appreciation Tax, but are reported on the transferor’s income
tax return and enter into the overall taxation of the
transferor’s net gains and losses for the year of the

Gain is recognized on a lifetime transfer of property, whether
marketable or nonmarketable. Recognition of losses, however, is

Except as provided below, an outright transfer of property other
than to a spouse or charity would be a recognition event. Gain
would be recognized to the extent of the difference between the FMV
of the property and its basis. Losses would not be recognized for
transfers of nonmarketable property or property transferred to
related parties within the meaning of section 267. The recipients
of such property would receive a carryover basis.

Under these rules, the ability to offset gains and losses upon a
transfer at death is largely eliminated. Although losses on gifted
marketable assets are recognized under the general rule, in
practice most gifts will be to a “related party” within
the meaning of IRC Sec. 267 and any loss will be denied.

Lifetime transfers to a spouse are treated differently:

Consistent with the general principle of the proposal and the
suggested deathtime transfer rule, outright transfers to a spouse
(as well as transfers that qualify for the gift tax marital
deduction) would be treated as realization events. Recognition
would occur upon the disposition of the property by the transferee
spouse, with the tax determined in accordance with the rules set
forth earlier. However, immediate recognition of gain property
could be elected. (footnote omitted)

Clarification of this rule is needed, in particular of the words
“(c)onsistent with . . . the suggested deathtime transfer
rule.” Would both gains and losses be realized upon a lifetime
transfer to a spouse, and would nonmarketable property be eligible
for loss treatment? Or would the spouse’s status as a
“related party” under IRC Sec. 267 mean that no loss is
realized? If the gift is to a trust for a spouse covered by IRC
Sec. 677, the trust will be a grantor trust and the transferor will
remain the owner of the property for income tax purposes.
Therefore, the gift will not be a transfer for purposes of the
Appreciation Tax (see below). An inter vivos QTIP trust is
also a grantor trust, but under the quoted language is perhaps
treated the same as an outright transfer because it will
“qualify for the gift tax marital deduction.”

Given the limits on loss recognition for gifts, when would it
make sense to elect to recognize gain on property transferred to a
spouse? If the transferor will have losses from non-donative
transactions on his income tax return, gain recognized by the
election may be offset by those losses. This reduces the deferred
Appreciation Tax, and would be beneficial only if there were no
“real” gains on the return subject to immediate tax that
could be offset.

These, and probably more, complexities will arise from
application of the “realization” rule to inter-spousal
transfers. As discussed below, we favor the simpler carryover basis
approach for spousal lifetime transfers.

G. Problems With Proposal

1. Marital Transfers

The Article does not adequately discuss whether interest is
payable when the Appreciation Tax is deferred upon a predeceased
spouse’s death and later paid upon a transfer by or the death
of the surviving spouse. Under the general approach, the
predeceased spouse’s death would be a “realization
event” but not a “recognition event,” even for
marketable securities; this suggests that interest would be payable
from the predeceased spouse’s death. Appendix B compares the
results in several examples with what would occur under carryover
basis. The differences are significant.

The Article says:

Prior proposals have treated the marital unit as a single
taxpayer for realization purposes. Thus, transfers to a surviving
spouse would not be treated as realization events, and the
decedent’s basis in the transferred property would carry over
to the recipient spouse. However, the decision to treat the marital
unit as a single taxpayer is a policy choice that introduces
several issues that must be addressed.

First, a marital exemption gives an executor the incentive to
transfer low-basis property to a surviving spouse and transfer
high-basis property to other beneficiaries . . . Second, the assets
used to fund a marital bequest would have to be identified before
the income tax liability of the decedent was calculated. Thus, an
executor would be required to claim tentative exemptions on the
decedent’s income tax return that reflected the property to be
transferred after death. Amended returns would be required if the
distribution differed from that originally claimed on the

An alternative, which would be consistent with the objective of
determining all gain and loss at the decedent’s death, would
recognize the special status of the marital unit but remove the
gaming opportunities and administrative difficulties presented by
treating the marital unit as a single taxpayer.

The Proposal does not eliminate the incentive to transfer low
basis property to the spouse and high basis property to others
because doing so still reduces the gain recognized upon the first
spouse’s death. Nor does it eliminate the possible need for an
amended return based on the final determination of the property
received by the spouse and other beneficiaries. The final
dispositions will determine the amount realized, which must be
reported along with the resulting deferred tax on an information
return. These arguments do not make a persuasive case against
treating the spouses as a unit.

Also, current IRC Sec. 2014 creates an incentive to rely on
portability of the estate tax unified credit rather than a bypass
trust. Property in a bypass trust will not receive a second step-up
upon the surviving spouse’s death. The Article’s approach
would eliminate this particular incentive to avoid use of a bypass
trust but would replace it with a stronger incentive, because
appreciated property passing to the trust may be subject to the
Appreciation Tax on the first death. The size of the basic
exclusion from the Appreciation Tax and how it compares in scope to
the estate tax AEA are relevant in measuring this incentive.

The Article’s concern is overridden by the opposition that
will arise against any imposition of a tax on a transfer from
spouse to spouse, even a deferred tax (which may eventually be paid
by the recipient spouse). The forty years since introduction of the
unlimited marital deduction have confirmed the belief that the
taxable moment for a married couple is the surviving spouse’s
death, not the predeceased spouse’s death.

The correct approach to marital transfers, both during life and
at death, is a carryover basis approach, under which no interest
would be payable for any period prior to the death of, or the
disposition of an asset by, the surviving spouse. If the asset is
sold, it will be replaced by another asset of the same value. If
the asset is distributed to the surviving spouse and is retained by
her until her death, no interest is payable because she is
receiving the income from the asset whether or not it is held in
the trust. However, if she makes a gift of the asset, interest
would be payable from the date of the gift in the same way the
interest would be payable if she received the asset outright
instead of through a QTIP trust.

For lifetime transfers, footnote 35 of the Article states:

An inter vivos spousal transfer does not raise the same
administrative issues as a deathtime transfer. See supra
Section II.A.5. Consequently, the decision could be made to exempt
those transfers from the general rule and account for the property
only upon disposition by the transferee spouse.

More fundamentally, under IRC Sec. 1041, no gain or loss is
recognized on a lifetime transfer of property from an individual to
(or in trust for the benefit of) the individual’s spouse. The
basis of the transferee spouse in the property is the adjusted
basis of the transferor. There is no sound reason for the
Appreciation Tax to seek to “override” IRC Sec. 1041. It
is wrong to treat a transfer that would not result in gain under
the applicable income tax rules, even if a sale, as a
“realization event” resulting in a deferred gain on which
a deferred tax will be paid, possibly with interest during the
period of deferral.

The Article concedes no reason exists to impose the
realization-deferred tax-interest regime on a lifetime marital
transfer. The administrative arguments for imposing it on marital
transfers at death are not persuasive. The correct approach, in
terms both of policy and of politics, is to exempt marital
transfers from the Appreciation Tax, and instead impose a carryover

If a carryover basis regime is not adopted for marital
transfers, clarification is needed with respect to the treatment of
QTIP marital trusts. A lifetime QTIP trust is a grantor trust and
in general a transfer to a grantor trust is not subject to
Appreciation Tax. However, because the transfer would be eligible
for the gift tax marital deduction, the Article appears to intend
that it would be treated in the same manner as an outright transfer
to a spouse, resulting in a realization event. Clarification is
also needed that upon the death of a spouse who is the beneficiary
of a QTIP trust, the trust is subject to Appreciation Tax even
though the trust property is neither owned by the spouse nor
subject to a general power of appointment, and that the trust
property should be aggregated with the spouse’s property in
calculating net gains and losses. These issues are discussed
further in Appendix B.

Inherited nonmarketable property generates a deferred tax
liability. The tax is not payable until the property is disposed of
in a recognition event. Death as such is not a recognition event,
and therefore the deferred tax generally will not be payable when
bequeathed by a recipient to a subsequent recipient. As discussed
above, although the deferred tax does not reduce the value of
property in determining the gross estate of the original owner, it
can be argued that the deferred tax liability reduces the value of
the property in the recipient’s estate, even though the tax is
not payable upon the recipient’s death. That would be a
favorable result, but in the context of a transfer between spouses
there may be a catch. If the deferred tax reduces the value of
property received by a spouse, it may reduce the value of the
property for marital deduction purposes in calculating the original
owner’s taxable estate, creating a gap between the gross estate
value and the marital deduction value. Perhaps the best rule is
that deferred tax does not reduce valuation for estate tax purposes
in any estate, reducing the taxable estate only when it becomes
payable, and therefore deductible. An executor should have the
power to elect to pay a prior decedent’s deferred tax, similar
to the election to recognize the decedent’s current realized
gain on nonmarketable property.

2. Nonmarital Lifetime Transfers

Additional lifetime transfers that should not result in an
Appreciation Tax are:

(i) A transfer for full and adequate consideration, taking into
account Treas. Reg. §25.2512-8. Transfers for full
consideration should not be taxable even if the transfer does not
result in the realization or recognition of gain for income tax
purposes and even if the transfer changes the ownership of the
transferred property for income tax purposes. An example would be
the transfer of appreciated securities for a partnership

(ii) A transfer that does not change the ownership of the
transferred property for federal income tax purposes, provided that
property owned by an individual that ceases to be owned by the
individual during life or upon death shall be subject to the
Appreciation Tax whether or not the cessation is a taxable gift or
is included in the individual’s gross estate. An example would
be a sale of property to a grantor trust for full and adequate
consideration, including a sale for a note. The sale would not be
subject to the Appreciation Tax, because the grantor continues to
be the owner of the trust property. The gain in the trust at the
grantor’s death or earlier if the trust ceases to be a grantor
trust, would be taxed, even if the trust is not includible in the
transferor’s gross estate.

3. Marketable Securities

“Marketable securities” are defined in IRC Sec.
731(c), a partnership income tax provision which, in general,
treats marketable securities as equivalent to money in determining
whether a partner receives a distribution of money in excess of the
basis of the partner in the partnership interest.

Marketable securities include “actively traded”
stocks, other equity interests, debt instruments, options, forward
or futures contracts, notional principal contracts, derivatives,
and foreign currency as well as interests in common trust funds,
mutual funds, instruments which are readily convertible into
marketable securities, instruments whose value is determined
substantially with reference to the value of a marketable security,
and most interests in actively traded metals. Interests in entities
substantially all of whose assets (90% or more by value) consist of
marketable securities and interests in other entities, to the
extent the value of their marketable securities is between 20% and
90% of the entity’s total value (“look-through
entities”), are also treated as marketable securities. Whether
bitcoin or other cryptocurrencies qualify will need to be
clarified. Property is actively traded if it is property for which
there is an established U.S. or foreign financial market.

Although the emphasis in the definition of marketable security
is on liquidity, some illiquid assets qualify. Thus, a share of
stock that is part of a class that is actively traded is a
marketable security even if its transfer is restricted by an
investment letter or if it is subject to an IRC Sec. 83 substantial
risk of forfeiture after an IRC Sec 83(b) election has been made.
No policy reason exists for treating property of this sort as
marketable securities while there are restrictions on sale.

4. Entities Owning Marketable

How to treat a nonmarketable asset that owns marketable
securities is a difficult issue. Despite the breath of the
definition of look-through entities, it can be expected that much
attention will be directed to converting marketable securities to
nonmarketable property (as long as that can be done in a way that
will avoid gain recognition under current law) to avoid the full
impact of the Appreciation Tax.

Transfers of property to a wholly-owned corporation can be
accomplished without current gain recognition and as long as less
than 20% of the corporation’s assets are marketable securities,
the interest in the corporation would not qualify as a marketable
security. The disregarded entity status of wholly owned limited
liability companies would presumably apply for Appreciation Tax
purposes whether or not less than 20% of the LLC’s assets were

The transfer by multiple transferors of appreciated property to
a partnership, LLC or corporation controlled after the transfer by
the transferors is, in general terms, not an income tax recognition
event under current law. However, the general rule does not apply
to transfers to an “investment company” where the
transfer results in a diversification of the transferor’s
interests and the transferee entity is a regulated investment
company (mutual fund), real estate investment trust or an entity
more than 80% of whose assets are held for investment and are
readily marketable stocks or securities (with the term “stock
or securities” being defined in a manner similar to the IRC
Sec. 732(c) list). “Diversification” is present where the
transferors transfer non-identical assets unless each transferor
transfers a diversified (as defined) portfolio of stocks and

Accordingly, there are possible avenues for a transferor, with
or without family members, to form an entity that will fail the
test for marketability.

A difficult issue for look-through entities is the time at which
the marketability test is applied. Could carefully balanced
deathbed transfers to a newly formed corporation convert marketable
securities into nonmarketable assets? Is the test applied at
formation or, given the possibility of asset value fluctuation and
asset re-deployments, only when there is a transfer subject to the
Appreciation Tax? Consistent with their purpose the IRC Sec. 731
regulations test for marketability at the time of a partnership
distribution, but this is a concept that would need to be modified
for purposes of an Appreciation Tax.

The Article’s proposed reliance on IRC Sec. 731(c) without
adjustments to define marketable securities seems misplaced.
Arguably this is the most significant unresolved issue in the
Article, and casts doubt on its fundamental proposal to treat
marketable and non-marketable assets differently. It should be
addressed in the statute, and not left solely to regulations.

5. Dynasty Trusts

The transfer of property during life or at death to an
irrevocable long-term “dynasty” trust may incur
Appreciation Tax, but subsequent appreciation within the trust
could remain free of Appreciation Tax indefinitely as long as the
trust is not included in any beneficiary’s gross estate. A
solution would be to provide that the Appreciation Tax applies to
any GST taxable distribution or taxable termination, with an
appropriate deduction to avoid double taxation. A strict version of
the rule would disregard the GST exemption and the trust’s
inclusion ratio in applying the Appreciation Tax.

A more difficult question is the treatment of a distribution of
appreciated property from a trust that is not a GST taxable
distribution, e.g., a distribution to a child from a trust for the
child. Should the distribution be subject to Appreciation Tax if it
does not otherwise result in recognition of gain? If so, how is the
basic exclusion from Appreciation Tax determined?

H. Other Developments

1. Van Hollen Proposal – the Sensible Taxation
and Equity Promotion (STEP) Act of 2021

On March 29, 2021, Senator Chris Van Hollen released a
discussion draft captioned “Sensible Taxation and Equity
Promotion Act 2021” which would provide for the realization of
property gains at the time of death and when transferred during
life. He said:

The stepped-up basis loophole is one of the biggest tax breaks
on the books, providing an unfair advantage to the wealthiest heirs
every year. This proposal will eliminate that loophole once and for

Other sponsors of the draft legislation are Senators Booker,
Sanders, Warren and Whitehouse. A similar proposal was also
introduced in the House of Representatives by Representative Bill
Pascrell, a senior member of the House Ways and Means Committee.
H.R. 2286.

The major points in the STEP Act are:

(i) Any transfer of property by gift or upon death would be
treated as sold. Thus, a tax on the unrealized appreciation would
be payable. A $1 million exclusion would be available. An exclusion
of $500,000 would be available for personal residences. An
exemption would be provided for (1) transfers to charitable
organizations and assets held in retirement accounts and (2)
transfers qualifying for the gift or estate tax marital

(ii) The proposal would be effective for transfers made on or
after January 1, 2021 and would contain no exception for
appreciation occurring before that date. A retroactive effective
date is unwarranted given the need to make changes in many estate
plans because of a new tax on appreciation.

The proposal contains no special rules for valuating farms and
other closely held businesses but does contain deferred payment
rules similar to IRC Sec. 6166 which defer tax for five years and
provide for payment over a ten-year period with interest at a
reduced rate.

(iii) A new section 1261 captioned “Gains from Certain
Property Transferred by Gift or at Death” would read:

(a) IN GENERAL. – Any property which is transferred by gift, in
trust, or upon death shall be treated as sold for its fair market
value to the transferee on the date of such gift, death, or



(A) IN GENERAL. – In the case of a trust for which the
transferor is considered the owner under subpart E of part I of
subchapter J –

(i) except as provided in subparagraph (C), subsection (a) shall
not apply to property transferred to such trust, and

(ii) subparagraph (B) shall apply.

(B) DEEMED TRANSFERS. – Property held by a trust described in
subparagraph (A) –

(i) shall be treated as transferred by the owner in a transfer
to which subsection (a) applies on any date that –

(I) the owner ceases to be treated as the owner under this

(II) such property is distributed to any person other than the
owner, or

(III) the property would no longer be included in the
owner’s gross estate under chapter 11, or and

(ii) shall be treated as transferred by the owner upon the death
of the owner.

(C) EXCEPTION. – Subparagraph (A)(i) shall not apply to property
if such property would not be included in the gross estate of the
transferor immediately after the transfer.

(2) NONGRANTOR TRUSTS. – In the case of any trust not described
in paragraph (1) –

(A) all property held by such trust shall be treated as sold for
fair market value on the last day of the taxable year ending 21
years after latest of –

(i) December 31, 2005,

(ii) the date such trust was established, or

(iii) the last date on which such property was treated as sold
by reason of this subsection (emphasis added), and

(B) proper adjustment shall be made in the amount of any gain or
loss subsequently realized for gain or loss taken into account
under subparagraph (A).


(1) TANGIBLE PROPERTY. – This section shall not apply to any
tangible personal property other than a collectible (as defined in
section 408(m) without regard to paragraph (3) thereof) which is
not held-

(A) in connection with a trade or business, or

(B) for any purpose described section 212.

The effect of the quoted language above in (2)(A) is that a
constructive transfer resulting in the realization of gain and loss
is considered made every 21 years. A constitutional issue may be
raised concerning the constructive transfer because there is
nothing that changes in the trust on which to base the imposition
of a tax. Arguably, some change is needed.

(iv) Section 1014 is amended to provide that for marital
deduction property the “transferee” takes the
“transferor’s” basis.

(v) A new section 6048A would require that certain trusts having
a value of $1 million or gross income of $20,000 supply information
concerning the trust to the Secretary of the Treasury.

(vi) A new section 199B would provide a deduction for costs
incurred in making a valuation appraisal.

(vii) A new section 6168 would provide an extension of time for
the payment of gains on certain assets for up to ten years and
would be available for an “eligible asset.” This term is
defined as:

any property other than personal property of a type which is
actively treated (within the meaning of section 1092(d)(1)).

Interest would be charged on any deferral of payment.

(viii) A special lien for taxes deferred under section 6168
would be created in section 6324C.

(ix) A severability clause stating that if part of the Act is
deemed unconstitutional, the remaining provisions continue in

An article discussing the STEP Act is Curry, STEP Act
Highlights Difficulty of Tackling Stepped-Up Basis, Tax Notes
Federal, April 22, 2021.

2. H.R. 2286

H.R. 2286 is a “condensed” version of the Van Hollen
proposal with some changes. Its version of the constructive
transfer provision quoted and underscored above states:


(A) IN GENERAL. – Any property that is continuously held in
trust and is not subject to subsection(a) for a period of 30 years
shall be treated as transferred pursuant to subsection (a) at the
end of such 30 year period.

held in trust on January 1, 2022, that has been continuously held
in trust for more than 30 years as of such date shall be treated as
transferred pursuant to subsection (a) on such date.

The reason for the differences in periods in the two bills is
uncertain. The constructive transfer provision in 1 and 2 would
attack dynasty trust.

I. General Explanations of the
Administration’s Fiscal Year 2022 Revenue Proposals (the
“Green Book”)

On May 28, 2021 General Explanations of the Administration’s
Fiscal Year 2022 Revenue Proposals (the “Green Book”) was
released. It refers to a tax on unrealized appreciation as


Treat transfers of appreciated property by gift or on death as
realization events.

Under the proposal, the donor or deceased owner of an
appreciated asset would realize a capital gain at the time of the
transfer. For a donor, the amount of the gain realized would be the
excess of the asset’s fair market value on the date of the gift
over the donor’s basis in that asset. For a decedent, the
amount of gain would be the excess of the asset’s fair market
value on the decedent’s date of death over the decedent’s
basis in that asset. That gain would be taxable income to the
decedent on the Federal gift or estate tax return or on a separate
capital gains return. The use of capital losses and carry-forwards
from transfers at death would be allowed against capital gains
income and up to $3,000 of ordinary income on the decedent’s
final income tax return, and the tax imposed on gains deemed
realized at death would be deductible on the estate tax return of
the decedent’s estate (if any).

Gain on unrealized appreciation also would be recognized by a
trust, partnership, or other non-corporate entity that is the owner
of property if that property has not been the subject of a
recognition event within the prior 90 years, with such testing
period beginning on January 1, 1940. The first possible recognition
event for any taxpayer under this provision would thus be December
31, 2030.

A transfer would be defined under the gift and estate tax
provisions and would be valued using the methodologies used for
gift or estate tax purposes. However, for purposes of the
imposition of this tax on appreciated assets, the following would
apply. First, a transferred partial interest would be its
proportional share of the fair market value of the entire property.
Second, transfers of property into, and distributions in kind from,
a trust, partnership, or other non-corporate entity, other than a
grantor trust that is deemed to be wholly owned and revocable by
the donor, would be recognition events. The deemed owner of such a
revocable grantor trust would recognize gain on the unrealized
appreciation in any asset distributed from the trust to any person
other than the deemed owner or the U.S. spouse of the deemed owner,
other than a distribution made in discharge of an obligation of the
deemed owner. All of the unrealized appreciation on assets of such
a revocable grantor trust would be realized at the deemed
owner’s death or at any other time when the trust becomes

Certain exclusions would apply. Transfers by a decedent to a
U.S. spouse or to charity would carry over the basis of the
decedent. Capital gain would not be recognized until the surviving
spouse disposes of the asset or dies, and appreciated property
transferred to charity would not generate a taxable capital gain.
The transfer of appreciated assets to a split-interest trust would
generate a taxable capital gain, with an exclusion allowed for the
charity’s share of the gain based on the charity’s share of
the value transferred as determined for gift or estate tax

The proposal would exclude from recognition any gain on tangible
personal property such as household furnishings and personal
effects (excluding collectibles). The $250,000 per-person exclusion
under current law for capital gain on a principal residence would
apply to all residences and would be portable to the decedent’s
surviving spouse, making the exclusion effectively $500,000 per
couple. Finally, the exclusion under current law for capital gain
on certain small business stock would also apply. (See IRC Sec.

In addition to the above exclusions, the proposal would allow a
$1 million per-person exclusion from recognition of other
unrealized capital gains on property transferred by gift or held at
death. The per-person exclusion would be indexed for inflation
after 2022 and would be portable to the decedent’s surviving
spouse under the same rules that apply to portability for estate
and gift tax purposes (making the exclusion effectively $2 million
per married couple). The recipient’s basis in property received
by reason of the decedent’s death would be the property’s
fair market value at the decedent’s death. The same basis rule
would apply to the donee of gifted property to the extent the
unrealized gain on that property at the time of the gift was not
shielded from being a recognition event by the donor’s $1
million exclusion. However, the donee’s basis in property
received by gift during the donor’s life would be the
donor’s basis in that property at the time of the gift to the
extent that the unrealized gain on that property counted against
the donor’s $1 million exclusion from recognition.

Payment of tax on the appreciation of certain family-owned and
-operated businesses would not be due until the interest in the
business is sold or the business ceases to be family-owned and
operated. Furthermore, the proposal would allow a 15-year
fixed-rate payment plan for the tax on appreciated assets
transferred at death, other than liquid assets such as publicly
traded financial assets and other than businesses for which the
deferral election is made. The Internal Revenue Service (IRS) would
be authorized to require security at any time when there is a
reasonable need for security to continue this deferral. That
security may be provided from any person, and in any form, deemed
acceptable by the IRS.

Additionally, the proposal would include other legislative
changes designed to facilitate and implement this proposal,
including: the allowance of a deduction for the full cost of
appraisals of appreciated assets; the imposition of liens; the
waiver of penalty for underpayment of estimated tax to the extent
that underpayment is attributable to unrealized gains at death; the
grant of a right of recovery of the tax on unrealized gains; rules
to determine who has the right to select the return filed; the
achievement of consistency in valuation for transfer and income tax
purposes; coordinating changes to reflect that the recipient would
have a basis in the property equal to the value on which the
capital gains tax is computed; and a broad grant of regulatory
authority to provide implementing rules.

To facilitate the transition to taxing gains at gift, death and
periodically under this proposal, the Secretary would be granted
authority to issue any regulations necessary or appropriate to
implement the proposal, including rules and safe harbors for
determining the basis of assets in cases where complete records are
unavailable, reporting requirements for all transfers of
appreciated property including value and basis information, and
rules where reporting could be permitted on the decedent’s
final income tax return.

The proposal would be effective for gains on property
transferred by gift, and on property owned at death by decedents
dying, after December 31, 2021, and on certain property owned by
trusts, partnerships, and other non-corporate entities on January
1, 2022.

The Green Book also states:

Tax capital income for high-income earners at ordinary

Long-term capital gains and qualified dividends of taxpayers
with adjusted gross income of more than $1 million would be taxed
at ordinary income tax rates, with 37 percent generally being the
highest rate (40.8 percent including the net investment income
tax),1 but only to the extent that the taxpayer’s
income exceeds $1 million ($500,000 for married filing separately),
indexed for inflation after 2022.2

This proposal would be effective for gains required to be
recognized after the date of announcement.

1 A separate proposal would first increase the top ordinary
individual income tax rate to 39.6 percent (43.4 percent including
the net investment income tax).

2 For example, a taxpayer with $900,000 in labor income and
$200,000 in preferential capital income would have $100,000 of
capital income taxed at the current preferential tax rate and
$100,000 taxed at ordinary income tax rates.

The date referred to is April 28, 2021. The Green Book does not
mention some items as to which changes had been mentioned as
possibilities, namely, (i) a cap on the income tax charitable
distribution deduction, (ii) reducing the applicable exclusion
amount, (iii) a change dealing with GRATs, (iv) other transfer tax

The discussion of the appreciation tax does not refer to the use
of the alternate valuation date in IRC Sec. 2032, which the Gutman
Proposal uses. Also, because carryover basis will be applied to
marital deduction property, a section formerly in the Code should
be reinstated, namely, IRC Sec. 2040 which was repealed when
carryover basis was repealed many years ago. It dealt with limiting
gain on the funding of a pecuniary legacy to post-death gain and
reducing the recipient’s basis by the unrecognized gain.

The effective date provision makes clear that trusts created
before January 1, 2022 are not subject to tax. Passage occurring
before Labor Day seems unlikely and would leave at most four months
for clients to make changes in existing estate plans. This is not
sufficient time for the process to work in a reasonable way. Also,
the use of the word “certain” needs to be explained in

It is useful to set forth a rule concerning the appreciation tax
as background for specific comments. The rule is that, leaving
aside the allocation of the $1 million exemption to a trust, every
distribution in kind of appreciated property by a trust is subject
to tax except for marital deduction dispositions and charitable
dispositions. Another point is that the Green Book refers to
outright marital dispositions but not to trust dispositions, which
should be covered.

No reference is made to state taxes on unrealized appreciation.
A deduction or credit should be allowed for some part of a state

We criticized the Gutman Proposal for making a distinction as to
carryover basis property between a recognizable and a realization
event with the result that upon a disposition of the property by a
spouse, interest was payable for the period from a decedent’s
death to the disposition. It appears that this distinction will not
be part of the Administration proposal and marital deduction
property will have a carryover basis with no interest until the
date of disposition.

The treatment of loss assets needs more explanation.

Will interest paid on deferred tax be deductible for estate tax

The Green Book says nothing about community property.

Decanting statutes apply in some states which permit the
amendment of certain trusts. What effect does such a statute have
on the application of the appreciation tax?

Are outright distributions of appreciated property from a
non-marital trust to a surviving spouse subject to tax?

The discussion of property transfers into and distributions in
kind from a trust, partnership or other non-corporate entity other
than a revocable trust is confusing and is inconsistent with the
general rule referred to above. No exception for a distribution to
the settlor’s spouse or a marital trust for the settlor’s
spouse is referred to.

IRC Sec. 2514(e) deals with a lapse of a power of appointment
and provides that a lapse is not treated as a release if it is
restricted to an amount that does not exceed the greater of $5,000
or five percent of the property subject to the power. Such a power
is often used to provide flexibility regarding the distribution of
trust property. If the power is granted to a descendant and is
exercised, the question becomes whether a tax would be incurred on
any appreciated property distributed to the descendant upon the
exercise of the power. If the answer is yes, a further question is
whether the powerholder has control over what property is deemed to
be exercised.

In some cases, a single family trust is created and the trustees
are given authority to divide the trust into separate trusts for
each child and his or her descendants. Does the exercise of such a
power cause a distribution of appreciated property to result from
the division?

The $1 million exclusion from recognition, which is indexed for
inflation, is too low even under the President’s test of not
increasing the tax for middle-income taxpayers and should be

J. Senator Wyden Proposal

In 2019, Senator Wyden, the current Chairman of the Senate
Finance Committee released a white paper captioned “Treat
Wealth Like Wages” which contains a basic framework for a
mark-to-market proposal to which would apply a lookback charge to
capital assets owned by individuals, estates or trusts with more
than $1 million in annual income or more than $10 million in
assets. Tradable assets would be marked-to-market and non-tradable
assets would have a lookback charge. See Tax Notes Federal,
February 8, 2021, p. 995. An article in Tax Notes Federal, Sapirie,
“A Time of Renewal for Mark-to-Market?” updates
developments concerning Wyden’s proposal. Tax Notes Federal,
April 12, 2021, p. 174. Also, Senator Wyden intends to introduce a
“mark-to-market” bill later this year. See Cadwalader
Cabinet, April 7, 2021. Wilhelm, Top Senate Democrat Pushing
Forward With Capital Gains Overhaul, Daily Tax Report, June 28,
2021. This bill would apply the proposal to living individuals as
well as to trusts.

K. Congressional Activity

After the brief description by the Biden administration of its
proposal for taxing unrealized gains (see page 2), reaction from
Congressional sources was quick.

Speaking for Senate Republicans, the Minority Leader said it was
“a second estate tax” and “This is a devastating
blow to family farms and small businesses all across America.”
This statement did not recognize the exception quoted on page 2
concerning family farms and small businesses.

On the other hand, 13 Democratic House members sent a letter
dated May 6, 2021 to three Democratic House leaders, Nancy Pelosi,
Speaker, Steny Hoyer, Majority Leader and Richard Neal, Chairman of
the Ways and Means Committee, which states:

As you work to develop a comprehensive infrastructure package
that prepares the American economy to grow and thrive over the
coming years and decades, and expands support for American
families, we write to express concern over the impact that certain
tax changes enacted to pay for this package could have on our
family farms and local economies. The repeal of stepped-up basis
for capital gains and immediate taxation could especially hurt
family farms, some of which have been in families for generations;
therefore, we strongly urge you to provide full exemptions for
these family farms and small businesses that are critical to our

We support many of the concepts outlined in recent weeks in the
American Jobs Plan and American Family Plan, including ensuring
that the wealthiest Americans pay their fair share. And while the
clear intention of making changes to stepped-up basis is to ensure
vast fortunes worth tens or even hundreds of billions are not
passed on without any income taxes paid at any point, we are
concerned about the unintended burden this could place on farms and
family businesses. We appreciate the President’s reference to
this burden and the need to address it in the outline of the
American Family Plan; and as representatives for districts that
would be directly impacted by that change, we hope you will see us
as a resource as we work to make that exemption a reality.

The requirement to recognize capital gains at death runs the
risk of forcing farms and ranches to sell part, or all, of a farm
that may have been passed down for several generations in order to
pay the tax burden. While the ability to simply sell a small part
of an asset may work for those with shares of stocks, it would
force farmers to break up land that may have been in their family
for decades and seriously impact their ability to remain
economically viable. Additionally, eliminating stepped-up basis
without an exemption for our farmers presents administrative
difficulties. For example, shares of stock or many other assets are
relatively simple to value, and taxing other assets when
they’re sold gives a clear reference price for valuation, so
capital gains taxes have thus far been relatively simple to
administer. However, since farms, machinery, and some small
businesses may be illiquid or difficult to value, the
administrative difficulty is increased.

We look forward to working with you as we develop a full
infrastructure package, and we again urge you to take additional
care in considering changes to stepped-up basis for capital gains
taxes. Farms, ranches, and some family businesses require strong
protections from this tax change to ensure they are not forced to
be liquidated or sold off for parts, and that need is even stronger
for those farms that have been held for generations. We would ask
that you work closely with representatives of rural districts like
us to ensure those protections are well executed. Many of our
constituents started working on their family’s farm when they
were children, or built their farm with the intention of passing it
on to their relatives, and we must ensure that their kids or
grandkids are able to continue working that land for future
generations. Thank you for your attention to this important

Also, more than 30 House Democrats have taken a similar position
on another issue saying they would not support an infrastructure
bill that did not include repealing the SALT deduction

Without the support of the representatives referred to, the
House would have problems in passing a bill dealing with the
taxation of unrealized appreciation of property included in a
decedent’s gross estate.

On May 13, 2021, Senators Cotton and Boozman, both from Arkansas
and Ernst from Iowa introduced the Estate Tax Reduction Act which
would reduce the estate tax to 20 percent. The same bill was
introduced in the House by Representatives Arrington, a Republican
from Texas and Cueallar, a Democrat from Texas. Tax Notes Document
Service, Doc. 2021-19747.

During her hearing before the Senate Finance Committee
concerning her appointment as Undersecretary for Tax Policy, Ms.
Batchelder answered a question from Senator Grassley of Iowa and
indicated that the Administration’s proposal to impose a tax on
unrealized gains would include an exemption for family farms. See
Bloomberg Law News, May 25, 2021, Condon and Davison,
Treasury’s Batchelder Aims to Bolster IRS, Opposes Digital

The House Ways and Means Committee is considering allowing
beneficiaries of estates to defer tax on unrealized appreciation
while the beneficiaries continue to hold the assets. See Cook and
Davison, Democrats Mull Weakening Biden Tax on Capital Gains
for Estates, Bloomberg Law News, May 24, 2021.

A Wall Street Journal article on June 8, 2021 contains an
article by Eliza Collins on page 4 of an interview with Senator Jon
Tester, a Democratic senator, which states:

Mr. Tester has raised objections to Mr. Biden’s proposal to
impose capital-gains taxes on unrealized asset appreciation upon a
person’s death, with the new revenue used to fund Mr.
Biden’s antipoverty or infrastructure plans. The tax has a $1
million per-person exemption, plus the existing exemption for
principal residences and special rules that would let farms and
other businesses defer payments so long as they are family-owned
and operated. Mr. Tester, like other rural Democrats, said the
proposal would hurt farmers and called it a nonstarter.

L. Increased Reporting for Trusts

The bills referred to in H.1. and 2. above contain a proposed
new Section 6048A which requires reporting of information
concerning trusts to the Secretary of the Treasury. The purpose of
this requirement is unclear. Perhaps it resulted from a recent
article in the November 30, 2020 issue of Tax Notes Federal, by
Rossotti, Sarin and Summers, Shrinking the Tax Gap: A
Comprehensive Approach. The article asserts that more
resources should be devoted to attacking the tax gap of
underpayment of owed tax liabilities and includes not only income
tax underpayments but estate and gift tax as well. The article
blames insufficient information reporting and inadequate technology
and lists specific areas where the Treasury “in consultation
with the IRS” can take immediate steps. One such area is
“an IRS notice can add gift and estate tax avoidance
strategies to the set of transactions that must be reported by tax

30 For example, grantor retained annuity trust, family
limited partnerships, and dynasty trusts. Cross-party reporting in
those cases could help the IRS target attention on the most
suspicious transactions.

However, the problem is not primarily “transactions”
but rather the law itself, as illustrated by Audrey Walton v.
Comm’r, 115 T.C. 589 (2000). The enactment of IRC Sec.
2701 created a loophole for GRATs that was not recognized. Also, as
to dynasty trusts, statutory change is necessary.

M. Conclusion

As previously noted, consideration and passage of the
Administration proposal in the year 2021 seems unlikely. The
proposal includes some elements of mark-to-market which involve
more than taxing unrealized appreciation at death of decedents. The
difficulties of developing an overall policy on the subject are
substantial. See Curry, Biden’s Vague Plan on Partnerships
Sparks Rampant Speculation, Tax Notes Document Service

The Administration may be delaying moving forward with repealing
step-up in basis at death until it has resolved the question of how
to handle farms and small businesses. Whether a delay in the
payment of taxes on such assets will be sufficient to satisfy
Congressional concern is uncertain. Unless this problem is solved,
sufficient votes may not be available for passage.

A compromise solution would be to reduce the applicable
exclusion amount to $5 million plus an inflation adjustment and
provide that the repeal of step-up in basis applies only to
property acquired after the effective date. The latter change would
“protect” existing farms and small businesses from change
for about a generation. The acquisition date of property acquired
by gift or bequest from a spouse would “relate back” to
the original acquisition date of the spouse.


Shortly after this article was completed another analysis
concerning the Administration’s taxing unrealized gains at
death was written. Jackel, No Escape: Proposals for Taxing Gains at
Death, Tax Notes Federal, July 5, 2021. This article confirms that
many issues are involved in doing a complete job.


Table Comparing Estates

Gross estate 50,000,000 50,000,000 50,000,000
Appreciation zero 50,000,000 25,000,000
Appreciation Exclusion n/a 1,000,000 1,000,000
Taxable appreciation zero 49,000,000 24,000,000
Appreciation tax zero 21,032,000 10,182,000
NY taxable estate (gross estate less appreciation tax) 50,000,000 28,968,000 39,818,000
NY estate tax 7,466,000 4,100,880 5,836,880
Appreciation tax plus NY estate tax 7,466,000 25,132,880 16,018,880
US taxable estate 42,534,000 24,867,210 33,981,120
US estate tax 17,565,300 9,615,245 13,716,504
Total tax: appreciation tax + NY estate tax + US estate
25,031,300 34,748,125 29,735,384
Effective tax rate 50.0626 percent 69.4962 percent 59.4708 percent


US estate tax: 45% rate on US taxable estate over $3.5

NY estate tax: 16% rate on NY taxable estate (less 534,000 to
reflect lower brackets)

Assumes New York has not adopted its own appreciation tax and
that New York recognizes the federal deduction of appreciation tax
in calculating the New York taxable estate.

Capital gains tax: Biden proposal: 20% on first million of
taxable appreciation, and 43.4% (39.6% + 3.8%) on balance. Gutman
article suggests exclusion, and we have assumed $1 million
nontaxable exclusion.

Switching dollar to appreciation generates .434 of appreciation
tax, and reduces estate tax by .1953 (.434 * .45) + .06944 (.434 *
.16) but increases tax by .031248 (.45 * .434 * .16). Net result is
+.434 – .1953 -.06944 + .031248 = .200508.

CHECK: A. .200508 * 25,000,000 = 5,012,700 B. 34,748,125 –
29,735,384 = 5,012,741


Questions Raised by the Proposed Approach to
Spousal Transfers

1. When tax is deferred upon a predeceased spouse’s death,
and later paid upon a transfer by, or the death of, the surviving
spouse, will the deferred tax be increased by the interest charge
that applies to deferred tax generally? The Article does not
address this question specifically for marital transfers, but under
general scheme the predeceased spouse’s death would be a
“realization event” but not a “recognition
event,” even for marketable securities, and therefore interest
would apply. This creates a significant difference from a carryover
basis regime, where there would be no interest charge when tax is
paid upon the surviving spouse’s death.

Marketable property passing to descendants upon the surviving
spouse’s death would immediately be taxed, in two tiers: the
first spouse’s deferred tax and the survivor’s separate
tax. Nonmarketable property would not be taxed on the surviving
spouse’s death. A nonmarketable asset passing from a
predeceased spouse to the survivor, and then to a child, would have
two deferred taxes when eventually transferred by the child: a
deferred tax computed upon the predeceased spouse’s death and
carrying interest from that date, and a deferred tax computed upon
the surviving spouse’s death and carrying interest from that
date. The second tax would be computed using the surviving
spouse’s basis, i.e., the value of the asset at the predeceased
spouse’s death.

Example 1: H dies leaving stock with a basis of 50 and a value
of 100 to W. During W’s life, the stock increases in value to
150. Under the Article’s proposal, there would be two taxes
payable: (i) a tax on H’s gain of 50 computed upon H’s
death but payable upon W’s death, with an interest charge for
the period of deferral between the two deaths, and (ii) a tax on
W’s gain of 50 (W acquired a basis of 100 upon H’s death),
with no interest charge. The total gain subject to tax is the same
as under a carryover basis rule, but the interest charge increases
the tax paid.

Example 2: Same as Example 1, except that during W’s life
the stock falls in value to 50. In a carryover basis regime there
would be no tax at H’s death or W’s death. Under the
Article’s proposal, W has a loss of 50 upon her death, which
does not offset the tax owed by reason of H’s death, but can be
used to offset W’s recognized gain on her other marketable
assets, and if the loss exceeds all such gains, to offset her gain
on her nonmarketable assets.

Example 3: H bequeaths a stock with a basis of 50 and a value of
100 to a testamentary QTIP trust. This transfer qualifies for
marital treatment because it is made “in any form that would
qualify for the estate tax marital deduction.” A gain of 50 is
realized but not recognized upon H’s death. During W’s life
and upon W’s death, the intended result of the proposal appears
to be that if the trustee sells the stock, the deferred tax on
H’s sale would be payable, with interest. However, the trust is
a separate owner and taxpayer from W, so clarification is needed
that this is the case. With respect to the gain realized and/or
recognized on W’s death, the QTIP trust presents questions. The
first is whether the trust property is subject to appreciation tax
by reason of W’s death. Clearly the answer should be yes, but
the Article’s general rule does not accomplish this result. The
general rule is that “death would be treated as an income tax
realization event for all property owned by a decedent, as well as
any property subject to a general power of appointment in the hands
of the decedent.” And footnote 21 to this language states:
“This realization rule would not depend on estate tax
inclusion rules.” The QTIP property is not owned by W or
subject to a general power, and therefore does not fall within the
general rule. Assuming that the general rule is revised to make
W’s death a taxable event for the QTIP property, upon W’s
death are there two taxpayers or one? Is gain realized and/or
recognized computed by a single calculation treating W’s
property and the QTIP property as one fund, or is the QTIP property
treated separately? Can W’s losses be offset against the
trust’s gains, and vice versa? The answer should be to treat
all property as if owned by W in calculating realized and
recognized gain.

Example 4: H makes a lifetime gift to a QTIP trust of stock with
a basis of 50 and a value of 100. Under the general rule, an
outright transfer to W would cause a realization of 50 of gain,
with tax deferred until a subsequent taxable event. The outright
lifetime transfer to W would clearly be a transfer for purposes of
the appreciation tax. The transfer to the QTIP trust should be
treated like an outright transfer, but the Article’s general
rule does not clearly accomplish this result. The general rule for
lifetime transfers is that “noncharitable transfers to trusts
would be recognition events when and to the extent the transferor
is no longer treated as the owner of the property for income tax
purposes.” The QTIP trust is a grantor trust and H remains the
owner of its property for income tax purposes. Clarification is
needed that the transfer to the trust is a taxable event treated as
if a transfer to W. (As such, it would be a “realization”
but not a recognition event, because “outright transfers to a
spouse (as well as transfers that qualify for the gift tax marital
deduction) would be treated as realization events”.
Additionally, clarification is needed that subsequent sales by the
trust are recognition events for H even though they are not sales
by W. The alternative would be not to treat the initial transfer to
the QTIP trust as a taxable event because H remains the owner for
income tax purposes, with the appreciation tax applying only upon a
sale by the trustee or upon W’s death. This approach would
eliminate interest on the tax. The treatment of the trust assets
upon W’s death would raise issues discussed under Example

Footnote 37 of the Article provides: “The proposal’s
application to lifetime transfers in trust, as well as to deathtime
transfers of property included in the decedent’s estate,
invites a reexamination of the differing rules regarding the income
and transfer tax treatment of transfers to trusts, with the goal of
establishing identical rules for the taxable event for both.”
Pending such a reexamination, the proposal needs to state specific
rules for QTIP trusts.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.