Small business tax nightmares

Small business owners across America are cheering the imminent demise of the estate tax, but Congress is poised to approve a little-known tax procedure that soon may give them headaches all over again, according to Bruce Bartlett, senior fellow at the National Center for Policy Analysis (NCPA).

The procedure is known as carryover basis. Why the nightmare? Bartlett explains, "Under carryover basis, the value of assets is no longer stepped-up at death. Instead, heirs inherit the original basis of the assets. So if a small business owner leaves at death stock worth $120 that he bought for $10, the survivor must pay tax on the full $110 appreciation, not the original price of $10 as current tax law provides."

Application of carryover basis also can be difficult. Since assets have historically been stepped-up at death, small business owners may not have kept complete records. And even when records exist, it is difficult to establish original basis when dividends, interest or other returns to capital have been reinvested over time. Then there's always depreciation and renovation for plant and equipment.

Conferees established carryover basis in the Tax Reform Act of 1976. Within six months, the outcry was so loud, Congress basically told people to ignore the law. And finally in 1978, Congress delayed implementation of carryover to its effective date-as though it never existed.

"The carryover basis provision Congress appears ready to endorse may not be the way to go. If it's enacted, I predict a repeat of the 1976 revolt with almost immediate pressure for its repeal," Bartlett said.

Bruce Bartlett's columns are distributed nationally by Creators Syndicate.