Estate Tax - The 2010 Step Up Basis Nightmare

The old saying is the best laid plans of mice and men so often seem to go wrong. When it comes to the government, this is a statement that is used the vast majority of the time since the bumbling of politicians creates some situations that are simply head shakers. This is exactly the case with the step up basis in estate tax for 2010.

This can get confusing, so let's start off with the basics. The step up basis is simply the value of some asset at a date in time from which a gain is calculated. Let's say I buy a share of Microsoft in 1990 [I wish!] and I sell it today. I would pay rather large capital gains taxes on the gain in value of that share of stock between 1990 and 2010.

The passing of an asset from a deceased person to their heirs triggers a bit of a different calculation. Let's assume the same situation as above. Instead of selling the stock in 2010, I die after being attacked by a bear [might as well make it exciting] in 2002. At that point, my stock is transferred to my daughter per my written will. This transfer constitutes a taxable event. Historically, she would pay tax on the gain from the date of my death till she sold the item. The use of my date of death allows her to "step up" the value of the stock instead of pay taxes on all the gains since 1990.

The Bush tax cuts were designed to reduce a number of taxes, but they went a step farther with the estate tax. They were designed to phase it out. In fact, there is no estate tax in 2010. That is nice and all, but the problem is the step up basis for capital gains above is now gone for the year. Instead of paying capital gains on the increase in value from the date of my death, she will have to pay them on the gains from 1990. That is a huge difference and constitutes a massive amount of money going out of my family and to the government. What did the government do for this money? Nothing, I just died!

Is there anything one can do about this mess with the step up basis? Unfortunately, there is not. It is simply another example of the government creating a mess with the best of intentions.

Avoid A Stock Trading Tax Nightmare! The Importance of Cost Basis for Capital Gains

Most people are used to paying income taxes on regular income from their jobs. However, many people get confused when it comes to paying capital gains taxes on stock trades.

There are no taxes due from buying stocks. In fact, if you held your stocks for the rest of your life, you would never have to pay anything to the government. Taxes only enter the picture when you sell.

At that point, it gets a little tricky. Your broker will then send the IRS a statement showing the proceeds of the sale. It is then important for you to determine the cost basis of those shares - i.e, the price and date that you bought the particular shares you just sold. The cost basis is needed to determine whether you have a gain or loss, and whether the gain/loss is long term or short term.

A long term gain or loss occurs when you have held the stock for at least a year and a day. If you held the stock less than a year and a day, it is a short term gain / loss. This is important because long term gains are taxed at a lower rate than short term gains. This is because the government likes to encourage long term investments, because they create jobs.

If you do not provide a cost basis on your tax return, the IRS will assume you bought the stock for $0 and it was a short term gain. This can cost you a lot of money!

For example, suppose that, in one year, you bought 1,000 shares of GE for $34, sold them for $32, and then used some of the money to buy 1,000 shares of HP for $20. Finally, you sold the HP shares for $22. You have broken even - you lost $2,000 on GE and gained $2,000 on HP.

However, the IRS will get a statement from your broker that you sold $32,000 of GE and $22,000 of HP. If you do not provide a cost basis on your tax return, the IRS will think you earned $54,000! They may come after you for back taxes and interest.