Estate Tax

Related Terms: Family Limited Partnerships; Retirement Planning; Succession Plans

Estate taxes are taxes levied on the value of an estate when it is passed to heirs upon the death of its owner. Estate taxes are often informally referred to as death taxes or a death tax. The entire value of an estate is not taxed which is why most Americans never have to pay estate taxes. Calculating the taxable portion of an estate is a complicated task usually taken on by the executor of an estate, a person named in the decedent's will.

In the simplest terms, the taxable value of an estate is the gross value of all assets within the estate upon the death of its owner, plus life insurance proceeds, minus outstanding liabilities and the cost of settling the estate. From the resulting value allowable deductions can be made and a well-planned estate is able to minimize the tax owed through the proper applications of these deductions. When an estate includes the assets from a family farm and/or a family business, higher deductions are available.

Many estates, upon the death of one spouse, will transfer, tax free, all assets to the surviving spouse, so long as he or she is a U.S. citizen. The question of estate taxes is, in this way, postponed only to arise again upon the death of the surviving spouse.

Recent changes in tax law have reduced the small number of estates subject to federal estate taxes. In fact, in 2006 less than 1 percent of all U.S. estates will be liable for federal estate taxes, leaving 99 percent able, if necessary, to pass on all of their assets to heirs on a federal tax-free basis. State taxes on inherited property are another subject. Each state assesses its own estate tax.

ESTATE TAX HISTORY

Many experiments with transfer taxes were undertaken before the Federal government enacted the Revenue Act of 1916, which introduced the modern-day income tax and also contained an estate tax with many features of today's system. The act was signed into law during a period of buildup to World War I. This was a time of growing budget deficits. There was also a general concern about the risks posed to a democracy by large concentrations of wealth, the era of the robber baron being very much in the lifetime of those governing at the time.

The estate tax rose almost immediately as the U.S. entered World War I. It continued rising thereafter and reached a top rate of 77 percent for the largest estates during the depression of the 1930s. The rates and the sizes of the estates affected by those rates fluctuated throughout much of the century. During the late 1960s and early 1970s tax reformers were focused on trying to close the many tax loopholes that had evolved over time. These efforts culminated in a 1976 tax bill that rewrote estate taxation, and established the system we had for the rest of the 20th century.

CURRENT TAX RATES

In 2001 the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was enacted. This act introduced tax reductions across the board and in particular a phased reduction of the estate and gift tax. The new law increases estate tax exemption levels also called unified credits. The exemption level provides all Americans with the ability to pass on to their heirs the first X number of dollars in their estate, X being the government established exemption amount for that year. EGTRRA calls for an increase in the exemption rate every two years—from 1 million in 2003 to 3.5 million in 2009. Then, in 2010, the estate tax is completely abolished for one year. EGTRRA also gradually reduces the top marginal federal estate tax rate to a low of 45 percent in 2009. It is the "sunset" provision of the act which is most striking. In 2011, unless Congress votes to repeal the tax altogether, or establish new tax rates, estate and gift laws will revert to their pre-EGTRRA form. The very unusual single-year abolition of federal estate taxes in 2010 has led to many jokes along the lines of the one in the title of a 2006 Money magazine article: "Could You Please Die Sometime in 2010?"

This law has been highly controversial and there is much uncertainly surrounding what will happen with estate and gift taxes after 2010. Congress was scheduled to vote on a permanent repeal of the estate tax in 2005 but the measure was tabled in the wake of devastating hurricanes that hit along the Gulf Coast in the summer. Although no legislation has been passed as of early 2006 to address the post-2010 period, most analysts believe that EGTRRA will not be allowed to "sunset" and that some new legislation will be enacted before the end of 2010. Writing in the Virginia Tax Review in 2002, Karen C. Burke described the situation this way: "Virtually no one expects to see the estate tax in its current form spring back into force in 2011. Instead, the 2001 Act is best viewed as an unstable truce between two contending political camps: on one hand, the root-and-branch tax-cutters who are determined to abolish the estate tax permanently, in several strokes if the goal cannot be achieved all at once; and on the other hand, skeptics who concede the need for estate tax reform but balk at outright repeal. Both camps have introduced bills staking out their respective positions, and the outcome of the battle over the future of the estate tax remains uncertain."

ARGUMENTS FOR AND AGAINST THE ESTATE TAX

The vast majority of Americans never have to pay estate taxes. This may be hard to believe based on the vehemence with which the subject is debated. The positions taken in favor of and against an estate tax tend to rest upon deeply held beliefs. How somebody answers the following questions is a sure predictor of where that person stands on the questions of estate taxation: Do the country's richest citizens owe an extra debt to society? Do they have, in Theodore Roosevelt's words, a "peculiar obligation" to those less fortunate?

Supporters of the Estate Tax

Estate tax supporters would tend to answer the questions posed in the affirmative.

Perhaps the principal argument in support of an estate tax is that it helps to make the tax burden on Americans more progressive. Proponents of an estate tax argue that such a tax serves to safeguard against the concentration of wealth and political power in the hands of a tiny minority. This in turn, they suggest, is essential for a healthy democracy. There is an underlying assumption implicit in the support of an estate tax and it involves an understanding about what is in the common good and that, as the old French saying goes, "noblesse oblige" (or nobility obliges).

The maintenance of a vibrant economy is aided by many commonly funded goods—a national infrastructure of roads, waterways, airports, and the like; an educational system open to all; an effective system of public safety and security; a just legal and political system, among others. Those who are most fortunate benefit particularly from these systems, and institutions according to estate tax proponents. They should, consequently, be willing to pay a fair share towards their maintenance—nobility obliges.

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