Article: 5
  Volume 16, April 5, 1999.
David G. Shaftel, 1999 © All Rights Reserved.

Internal Revenue Code Section 1014 provides one of the few benefits of dying. The basis of property owned by the decedent is adjusted to its fair market value. In community property states, this benefit is doubled. Not only does the decedent's one-half of the community property receive an adjustment in basis, but also the decedent's spouse's one-half of the community property receives a similar adjustment. As previously reported in this column, in 1998 Alaska adopted an optional community property system. One goal of this new Act is to obtain the above-described community property full adjustment in basis for couples owning Alaska community property.

The Alaska Community Property Act, effective May 23, 1998, is based upon the Uniform Marital Property Act, which had previously been adopted only by Wisconsin. However, unlike the Uniform Act, the Alaska Act is an optional community property system. As a general rule, Alaska's established separate property system will apply to marital property. However, spouses may elect to have some or all of their property treated as community property. If both spouses are domiciled in Alaska, the election occurs through the execution of a community property agreement or community property trust. If one or both spouses are not domiciled in Alaska, then this election can be made by the transfer of property to a community property trust.

In the Administration's Revenue Proposals issued in February of 1999, the Department of the Treasury has proposed elimination of the I.R.C. §1014(b)(6) basis adjustment for the one-half of the community property owned by the surviving spouse. Treasury introduced its reasons for the change by stating that "at present, there are nine community property states and at least one other state with an elective community property regime." Then, the General Explanation states:

When enacted in 1948, the stepped-up basis for community property was premised on the fact that "the usual case was that practically all the wealth of the married couple was the property of the husband." S. Rep. 1013, 80th Cong., 2d Sess. (1948), 1948-1 C.B. 285, 304. Societal changes and changes to the estate tax treatment of jointly held property in 1981 have undermined the premises on which section 1014(b)(6) was based. Consequently, surviving spouses in community property states now enjoy an unwarranted tax advantage over those in common law states.

The Treasury Department's concern is the unequal treatment of residents of community property and separate property states. Treasury does not explain the "societal changes" upon which it is basing its proposal. One may speculate that these changes are the more equal ownership of family assets between spouses, often resulting from sound estate planning advice. However, even if such ownership changes are occurring, elimination of the full basis adjustment is only one remedy for the disparity of treatment between community property and separate property states. That remedy may not be the wisest.

After one spouse dies, it is often necessary for the surviving spouse to sell certain assets. The family business may need to be sold due to the decedent's lack of participation, or pursuant to an existing buy-sell agreement. Real property may be considered burdensome to manage. Market conditions may dictate the sale of assets before an expected downturn. Assets may need to be sold in order to raise funds to replace the decedent's earnings. The full basis adjustment of I.R.C. §1014(b)(6) alleviates the post-death tax burden resulting from these necessary sales.

At present, there is a significant push for tax relief. The nation has a budget surplus. In these circumstances, there is an alternative remedy which would both achieve equality between community property and separate property states and provide needed tax relief. This remedy would be to extend the full basis adjustment to any form of jointly owned property which is equally owned by only husband and wife. Such property would include community property, joint tenancy, tenancy by the entireties, and tenancies in common.

There is direct legislative precedent for this alternative approach on very similar facts. In the mid-1940s, one-earner families in separate property states were required to report all of their income on a single return. In contrast, couples in community property states could each report one-half of the family income. As a result, Oklahoma, Oregon, Michigan, Nebraska, and Pennsylvania all switched to community property systems. Congress became concerned about the lack of geographical equalization in the treatment of the income of married couples. The remedy was not to deny the ability to split income to couples in community property states, but rather was to allow all couples to income split by filing a joint return. S. Rep. 1013, 80th Cong., 2d Sess. (1948), 1948-1 C.B. 285, 301.

The above-described alternative remedy to the Treasury's perceived tax inequality seems wiser tax policy than elimination of a benefit which the residents of community property states have received for over 50 years. In short, if a legislative change is to be provided, then the full basis adjustment of I.R.C. §1014(b)(6) should be extended, not eliminated.