15-Dec-20
The Federal Estate Tax
Take-Away: If one thing is certain, it is that with every new Congress, some representative will file a Bill to repeal the federal estate tax. Other than the one-time event in 2010 which provided a federal estate tax ‘holiday,’ each Bill to repeal the federal estate tax will disappear, only to be refiled in the next Congress.
Background: The federal gift and estate tax produces roughly 1% of the federal government’s revenue
Arguments for Repeal: Several arguments have been made over the decades why the federal estate tax should be repealed.
- It Produces Little Revenue: This is a true statement, when you consider that each individual has an estate tax exemption above $5.6 million. If the federal estate tax exemption returned to $60,000 per person (back when I first started practicing law,)that lower exemption would raise considerably more revenue when the estate tax is imposed.
- It is a Double Tax: When an individual claims that he or she is ‘double taxed’ at their death, that is not entirely accurate. The federal estate tax is not actually borne by the decedent. Rather, it is borne by the decedent’s beneficiaries- the tax is just collected at the estate ‘level.’ This complaint about the federal estate tax also tends to overlook the step-up in income tax basis on the deceased owner’s death. [IRC 1014.] While the income that enabled the purchase of assets is taxed ‘twice’ once when earned and a second time when the asset his held until the earner’s death, the appreciation on that asset purchased with after-tax income, escapes federal income taxation. Anyone who sits on a pile of Apple stock until death will never pay any tax on the appreciation of his or her Apple stock. The double taxation is more clear for savers, who pay a tax on their income, and then simply save their after-tax income, which gets taxed a second time on the saver’s death.
- It Discriminates Against Small Businesses and Farmers: There is no evidence that the actual number of farms in the United States has decreased due to the federal estate tax. If the number of farms has been reduced over the years, that reduction may be attributed to mismanagement, farm children choosing careers in cities other than the hard life and long hours of a farmer, or more likely the increase in the number of ‘corporate farms’ that exploit economies of scale. If the federal estate tax disappeared, would corporate farms disappear as well? The same can be said for small businesses; the federal estate tax may force the business to be sold, but the business will continue, just in new hands. Recall, too, that much of the federal estate taxes attributed to the value of the farm or closely held business can be spread and paid over 14 years from the date of the owner’s death, if the owner engaged in some advance planning.
- It is Too Complicated to be Effectively Enforced: This statement is true. But it is true only because Congress has collectively decided to include multiple exceptions and exclusions to the federal estate tax. The estate tax could be greatly simplified if there was no marital deduction, no $5.6 million exemption per person, no special use valuation rules for closely held businesses and farms, no installment payment options for small businesses and farms, etc. It is complicated because Congress makes it complicated with its ‘add-on’s and special interest exceptions. [Anyone remember the Gallo Rule when exceptions to the GST were being adopted?]
- There Are Better Alternatives: As noted earlier, there is some interest in looking at a capital gains tax on death as a substitute for the federal estate tax. However, it is obvious that such a tax on gains would fall on all individuals on the wealth spectrum, which is contrary to the efforts to impose a wealth tax which would only take wealth from the very wealthy in society. That might be why in his preliminary proposals, President-elect Biden proposed a $1.0 million exemption from the ‘capital-gain-tax-on-death’ that he is taking a close look at. Another options, but just as regressive as a capital gain tax on death, would be a value added tax (VAT) used in many countries around the world. A VAT is a consumption tax and is more regressive than an income tax or an estate tax because it taxes spending, and because wealthy save more than those who are less wealthy. A capital gain tax at death or a VAT might raise more revenues, but all in society would find themselves paying more, not just the wealthy.
- Estate Tax Reform is Impossible Due to ‘Politics:’ The cynic in me suggests that this may be the real reason why the federal estate tax does not disappear. Studies have shown that the topic that is most likely to attract campaign contributions to a candidate is the repeal of the federal estate tax. There is no real political will to eliminate the estate tax when it attracts so much in the way of political campaign contributions to candidate who campaign promising to go to Washington and end the dreaded estate tax.
Conclusion: For those individuals who claim that the federal estate tax leads to ‘double taxation’ they would probably accept (reluctantly) a capital gains tax on death as a substitute for the repeal of the federal estate tax. That is one tax that President-elect Biden is taking a serious look at, possibly modeling that capital gains tax on death after the Canadian system. The VAT might get some attention, but because it is so regressive and hurts the non-wealthy, it is unlikely to go very far as a substitute for the federal estate tax. As for the Sanders-Warren wealth tax proposals made during the Presidential primaries, that is not likely as an alternative to the federal estate tax for reasons set for in the next missive.