The bid to end the “death tax” appears itself to be dead. The Senate’s 57-41 vote last week in favour of a bill to repeal the estate tax fell short of the necessary 60 votes. Counter-intuitively, for most wealthy Americans that is far better than repeal.
“This is the first step to going toward a compromise,” says John Barrie, a partner in the New York office of Bryan Cave, the law firm. “It brings to closure the debate over total repeal. It is effectively dead.”
Bill Gates and Warren Buffett, America’s two wealthiest men, make clear they are willing to pay the tax in any case. But the average very rich person might benefit from the approach that now seems likely: a rise in exemptions, combined with a cut in the estate tax rate.
In 2001, George W. Bush appeared to put the tax on life support when he set in motion legislation to raise the exemption progressively until it is eliminated altogether in 2010, only to have the original 55 per cent level and $1m exemption come roaring back to life in 2011. The current rate is 46 per cent and the exemption is $2m for an individual, or $4m for a couple.
The policy arguments over estate tax are by now rote. Those against it (usually Republicans) say it is unfair; those for it (mostly Democrats) say it redistributes wealth. Chris Edwards, head of tax studies at the Cato Institute, a libertarian think-tank in Washington, makes the argument for the former: “This is often money that has already been taxed when people earned it.”
But the numbers suggest that suffering at the hands of the estate tax is not widespread. In 2004 there were 30,276 estate tax returns out of 2.3m people who died that year. Only 3,500 estates were greater than $5m, and they paid about two-thirds of the total estate taxes, according to Joanne Johnson, wealth advisor at JP Morgan Private Bank.
As for the myth that family farms are lost to a rapacious estate tax, Joshua Rubenstein, New York managing partner of law firm Katten Muchin Rosenman, calls this “completely ridiculous”. He points out that the federal government offers low interest, 15-year loans to pay estate taxes if a farm or family business is more than 35 per cent of the estate. “In my 27 years of practising law, I have never seen the business sold because of estate taxes,” he says. “I’ve seen it sold because of the incompetence of the heirs.”
Mr Rubenstein says the estate tax is hugely beneficial to any American who dies with something to pass on to heirs. “People keep crappy records during their lives,” he says. “One of the things you get is a step-up in basis, even if you don’t owe estate tax.”
This “step-up” refers to the basis on which capital gains tax is paid. If an individual dies with a house worth $2m he can pass it on to his heir tax free, since it falls under the current $2m estate tax exemption. If that house originally cost $100,000 when he bought it 30 years ago and there was no estate tax, his heirs would have to pay capital gains tax on the $1.9m difference, notes Mr Rubenstein. With an estate tax in force, the heirs instead get a step-up in basis to $2m – as if they bought it that day at that price. They will only pay capital gains tax on profits above that amount.
He says: “99 per cent of Americans don’t pay estate tax, but 100 per cent are subject to capital gains tax.”
In this sense, a total elimination of the estate tax could hurt poorer Americans more than wealthier Americans, who can afford superior tax planning and wealth management services.
A bigger issue is gift and generation-skipping transfer tax (GST). The GST was enacted so that all family property would be subject to a tax (whether gift tax, estate tax or GST) at least once in each generation. Jointly, these taxes limit how much a person can transfer to family members while alive.
Ms Johnson notes that the exemption from gift tax in a lifetime is capped at $1m per person but that amount also goes against your estate tax exemption. “Your generation-skipping exemption goes up to $3.5m but your gift tax is limited at $1m. If you wanted to create a dynasty trust in Delaware, you could pay tax on $2.5m.” If there is no change to the gift and GST tax rates, now at 46 per cent, they, too, will revert to 55 per cent in 2011. “There hasn’t been the focus on it,” says Mr Barrie. “The revenue cost is minimal for a gift tax, yet a lot of people spend a lot of money now to minimise it.”
For now, the estate tax rate is in flux. “If you are in your late 70s or early 80s and you are planning your estate you have to take into account that you could die in 2010 [when there is no tax] or 2009 or 2019,” says Mr Barrie.