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Tax Reform 2017 – The Estate Tax

Tax reform is on the table again, and it’s time to start looking at the individual parts of the code up for discussion. Today, I’d like to look at the estate tax. Those who want to repeal it entirely are fond of calling the ‘Death Tax’, as that will stir up some repulsion in their constituents, and support for them.

First, let’s look at a bit of the history of the estate tax. In 2001, shortly after my daughter was born, the exemption was $675K. At that time, my wife and I were going to do the ‘responsible’ thing and get life insurance, term policies. $1M each, which was pretty cheap at the time as we were still young. But this meant that if we died, we would leave our child $2M of which $700K would be subject to tax. On top of that, our 401(k) and IRAs would add to this number, and every bit of it taxed. Even at that earlier stage of investing, I knew enough to start planning. $2000 and one trust later, we did not own the insurance, it was owned by the trust, and bought with money gifted to our daughter. The estate tax was always up for discussion and it quickly was raised in the late 2000’s. In 2017, it’s $5.49M per person. And there’s a little additional benefit, the preservation of the exemption for the second to die spouse. This means that if I die tomorrow, in effect, my wife can leave our daughter the $10.98M with no tax due. Just a form to send in when I meet my maker. No need for any lawyer or trust. And no, we’re nowhere close to worrying about hitting that number. Further, we can gift her $28K/year from now until we pass. That’s close to another million dollars. And $28K/yr to her spouse if and when she gets married, or even to her ‘special friend’ if she stays single, and we’re generous. When you bring on the grandkids, the numbers multiply up fast. A couple with 2 children and 4 grandkids has 8 people to gift to (including the spouses) which adds to $224K/yr under the current limits. If one has the money and sufficient offspring, it’s not tough to gift away another $6M or so depending on the situation.

When you look at the distribution of wealth, the data show that only the top .2%, 1 in 500, estates owe any tax at all, and for those who just go over, the tax is minimal. It gets to be quite a bit when billionaires pass away. Say someone worth $10B passes. The $10.98M exemption is tiny compared to this number, and the estate can owe close to $4B.

When politicians push for this cut, until now, it wasn’t because they were rich, that tax wasn’t likely to affect them either. They had some very large donor whose money they wanted to keep flowing. The politicians are great marketers, talking about the ‘small farms and family businesses’ hurt by the estate tax. Let’s talk about farms for just a moment.

Exact numbers aren’t easy to come by, but we have a good hint. Only 3% of family farms have sales over $1M. This results in a value of $5M or so, given that $1M isn’t profit, but gross sales. This type of business is typically valued at 7X profits. It’s not hard to assume that to get past $11M in value we are at fewer than 1% of farms. Now, if the whole point is that the kids want to keep the farm and stay with the business, it would be easy to use the strategies I suggested above. Giving not money, but a percentage each year. Yes, it takes a tax attorney, and yes, the tax code is convoluted, but we are back to the “family farm” rarely being lost to estate taxes. The repealers post, tweet, and write about it as if each and everyone in the country should be outraged over this tax, while 41% of us are not even making $15 per hour. They would like to give their wealth patrons this windfall, but will look to cut SNAP funding by $125B, cut Pell Grants and other pro-college funding, and perhaps worst of all, repeal the ACA.

If you are in favor of repeal, would you mind dropping me a note and explaining why you support it? Given how few will benefit from repeal, I’m very curious. I’ve never heard a real legitimate reason.

  • Nathan September 5, 2017, 10:46 am

    The only convincing argument that I’ve heard is that there are some family businesses that are large enough to require that the business be sold to pay the estate tax. This concern could be eliminated if the government allowed an audit to establish the value of the company, and then a payment plan set up to pay the government its share of the profits until the estate tax was finally paid in full.

    The downside of such a plan is that the children may not be as business savvy as the parents, or too clever by half, so when the business fails due to the children mismanaging the business (accidentally or deliberately) the government gets the shaft. Actually I imagine a new cottage industry might appear thinking up creative ways to loot the business and then send it into bankruptcy so that the government doesn’t every get the estate tax proceeds.

    It seems like private equity is the answer for how children should sell a portion of their business to pay the estate tax, and perhaps there should be a longer window before the tax is due. Some of the damage might also be solved by tinkering with the rates a little bit. In the end it’s a first world problem and a probably not a tragedy that gains a lot of sympathy when a millionaire heir has to sell the family business when s/he inherits it.

  • Joe September 6, 2017, 5:30 am

    I appreciate your observations. The part that disturbs me most is the smokescreen aspect. As I tried to offer in this article, the tax went from one that would have the potential to hit the estate of any properly insured couple, (our situation back in the late 90’s) to one that only hits .2% of estates. The focus on the farmer or small business should tell you something. The billionaires, such as our president, would prefer to paint some sympathetic picture, or rather, a Norman Rockwell painting, of some family about to lose a business because of this tax. Not about the $4B he’d prefer not to have his estate pay.

    I’ll be the first to agree, the system is convoluted, but the jump to $11M per couple is enough. When a number is so high that most of us can’t imagine getting to that level, and, in fact, a good tax guy can stretch to at least double that number, I don’t have sympathy. It’s called financial “planning” for a reason. You also probably know there are large discounts for shares of illiquid businesses? When I take my $20M company and create 20,000 shares that should otherwise be valued at $1000 each, they are not. The fact that these shares don’t have a ready market allows for a discount (The exact details are above my pay grade, this is not my expertise) and readily giftable to the next generation(s).

  • Nathan September 6, 2017, 5:21 pm

    Yes, the fact that the taxman is waiting for the payment gives any prospective buyer/investor incentive to drag their feet to get a better deal as the deadline to pay the tax approaches. That’s why I would suggest a longer window before the tax is due. It probably wouldn’t change the status quo significantly.

    I would be interested to see what the actual numbers are for how much revenue is generated by the inheritance tax compared to the size of the estates that they are targeting. Bill Gates and Warren Buffett will have the majority of their fortunes passing into one large charitable foundation. Maybe there should be an AMT on donations of that sort to charity. In any case, I am certain that they won’t be giving the government anywhere in the ballpark of 40% when they pass.

    You’re certainly right about the smoke screen. Everyone gives a moral justification for why the tax code should be tinkered with in one direction or another (to the benefit of the person suggesting the tinkering).

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