TexasProud: "BUT, in your example it would seem that the business has grown in value over that long amount of time... and the father did not pay any cap gains on that growth... why should the business be given to the children and no cap gain paid And the kids would not have to pay it since there is a step up in basis..."
Part of the answer to that is this. The kids don't necessarily have it. The first generations estates may not have it either. Consider a situation where most of their wealth is tied up in the business. So....the business would have to be liquidated to pay the tax.
Tell me ...how does one pay the government? They want cash.
While the 1st generation may not have paid cap gains....they paid income taxes all along the way. In the case of a C corp...if dividends are declared they pay double tax. The corporation pays a tax on the profit and the people receiving the dividend pay a tax. The government gets their share all along the way.
If cap gains for a business could be calculated the way it is ...say for a house...which is when you invest back....it raises your basis...then I daresay there would be no cap gains in a small family business.
The taxes paid along the way was income taxes... it is money that is 'somewhere else', not in the business...
So lets get some agreements... first, the business has to be worth a good amount to be taxed... if it is a small business, then there is no value and no tax... correct?
Second, if a C corp, you are right... double taxation.... but if the corp has not paid out dividends... then it has only been taxed once where everybody else's dividends have been taxed twice.... so we still have something that has not been taxed with an income tax in the estate...
The value of the company is not just the cash... it is the ability to make more cash... so if the grand dad started it with $100 and built it up so it would be taxed (say it is $1 million value, but only $400K taxable since there was a $600K exemption back then)... there is $1 mill of gain that has not been taxed... the dad would take over the business and he could sell it the next day for $1 mill and pay no income tax... so there was never any tax paid on this gain... but, the estate paid tax on the $400K..
Now.. the gvmt allowed this to be paid over 15 years... (IIRC).... so now son has a $1 million business he did not pay for, but the estate has (lets just say) a $100K tax bill...
Dad now builds the business to be worth $10 mill... yes, paying taxes along the way on the income, but not the increase in the business... go through the same math etc. etc.... we have $9 mill of cap gain that has not been taxed with income tax...
Now... all this means nothing if grand dad had invested $10 mill and it was still worth $10 mill when he died... but had to pay an estate tax... and then dad died and it was still worth $10 mill.... and paid an estate tax that is where the estate tax is not fair....