bc law school magazine
W(H)ITHER ESTATE TAXES?
by Ray D. Madoff (Illustration: Gil Adams)
The Economic Growth and Tax Relief Reconciliation Act of 2001, which phases out the estate tax only to reinstate it in 2010, is an absurd piece of legislation that accomplishes little of substance other than sowing confusion and cynicism about our tax system. Congress should repeal the 2001 Act and decide once and for all whether to retain the estate tax or permanently repeal it. I, for one, strongly believe that our tax system is better and fairer with an estate tax and that it should be retained and fortified.
There is a common misperception that the 2001 Act dealt a death blow to the estate tax. Indeed, the act does provide a gradual increase of the amount that can be passed tax-free, from $675,000 in 2001 to $3.5 million in 2009, and repeals all estate taxes and generation-skipping transfer taxes as of January 1, 2010. However, like a phoenix, the tax reappears one year later with a $1 million exemption amount and a 55 percent maximum tax rate.
This repeal-reinstatement scheme makes it extremely difficult for people to plan their affairs, since their expected tax liability will change significantly from year to year, depending on the date of death. It also creates absurd incentives for taxpayers to die in 2010. If someone dies on December 31, 2010, her heirs pay no taxes; if she dies a day later, more than half of her estate could go to the government. The situation has given rise to references to the movie Throw Momma from the Train and suggestions for celebrating birthdays in 2010 with hang gliding and warm chicken salad.
I understand the initial appeal of the arguments in favor of repealing the estate tax. The name "death tax" invokes the visceral sense that the estate tax is the ultimate insult to injury--death is bad enough without imposing a tax liability too. Double taxation is another rallying cry against the estate tax since the money subject to the estate tax was presumably taxed when earned by the decedent. Finally, there is concern that the estate tax system is full of loopholes and can easily be avoided by those with sufficient resources to hire skilled estate planners.
Despite these concerns, I support an estate tax for the following reasons. The elimination of estate taxes will not occur in a vacuum. Less revenue derived from estate taxes will mean more revenue must be raised from other sources likely to be more burdensome for Americans as a whole. The estate tax system allows for significant amounts of wealth to be passed free of tax. All transfers to spouses and charitable organizations are exempt, and generous exemptions exist for other beneficiaries, such that the tax is imposed only on those with significant wealth. Moreover, rather than being imposed at an inopportune time, the estate tax is levied when it causes the least harm. The dead do not feel the pain of the tax; the burden is borne by nonspouse beneficiaries. The law does not recognize any right of these beneficiaries to inherit from the decedent. Taxing their inheritance, therefore, does not subtract from money they already possess.
The double taxation argument overlooks the ways in which transfers at death are advantaged in the income tax world. Inheritances are not subject to income taxes. If a person inherits $50,000, she will receive the full $50,000, unreduced by income taxes. Moreover, property received through inheritance gets a fair market value basis. This means that if a person inherits stock that appreciated when held by the decedent, no capital gains taxes are ever paid on that appreciation. These advantages are often justified as a fair trade-off for the imposition of the estate tax. Yet, while the 2001 Act repeals the estate tax, it leaves in place the numerous tax benefits for transfers at death, making inheritances significantly tax-advantaged over other types of income.
Are estate taxes easily avoided? It is hard to believe the estate tax would raise the revenue it does if that were completely true, but the tax is not air-tight and the well-advised can often reduce their estate tax liability.
The appropriate response to concerns about the fairness of the estate tax is not to throw it out. Rather, just as the income tax system is constantly being updated to close loopholes, so too should the estate tax undergo rigid scrutiny and revision to make it as fair as it can be.
Professor Ray Madoff is the lead author (with Cornelia R. Tenney and Martin A. Hall) of the recently published Practical Guide to Estate Planning (Aspen 2001). This practice-based guide provides plain-English explanations of simple and sophisticated estate planning techniques and fully annotated estate planning forms.