TAXES: Estate tax could meet its death this year
In the upcoming political season, there will be a lot of discussion about tax reform. While much of the debate centers upon the all-too- familiar income tax, another tax reform issue will concern the estate tax, which is imposed on wealth transfers at the holder’s death.
The estate or “death” tax is almost as old as the republic. The first federal death tax was a “stamp tax” enacted in 1797 to pay for a naval build up responding to tensions with France. Subsequent estate taxes have been reenacted to raise revenue for the Civil War (1862) and again to raise revenue for the Spanish American War (1898).
The tax was not permanent until the Revenue Act of 1916, which contained the original income tax, was enacted. This act also contained a permanent estate tax.
While Congress raised and lowered the rates of taxation, it was not until passage of the Tax Reform Act of 1976 that the Estate and Gift Tax was combined into a unified tax credit.
Current tax formula:
Under the Estate and Gift Tax as it now stands, each individual is entitled to exempt the first $650,000 (for 1999) of his or her estate from taxation upon transfer, during lifetime or at death. This exempt amount will gradually increase to $1 million per person by the year 2006. Transfers to spouses receive an unlimited deduction (transfers are not taxed). Bequests left to charitable organizations receive similar treatment.
Arguments in favor of retaining the tax:
This tax assists in reducing the inequality of wealth and prevents the build up of dynasties. The American way, it is argued, is one of profiting from one’s own hard work. Our society is not built upon the concepts of title and inherited wealth. Therefore, arguably, this tax only applies to the rich in our society. It does not affect the poor or the middle class.
Next, it is argued that taxes are enacted for reasons beyond the raising of revenue. One is to influence social behavior. The deduction for gifts to charitable organizations promotes the transfer of monies to organizations that might not otherwise receive necessary funding.
These charities in turn assist society by providing services that the government would otherwise be compelled to provide. Were the incentive to fund these organizations eliminated, there would be a decrease in giving and a corresponding decrease in necessary services.
Lastly, it’s argued that the gift and estate taxation system raises necessary revenues, the loss of which would have to be made up in some other funding (tax) source.
Arguments in favor of eliminating the tax:
First, the tax may not eliminate inequality and assist in the redistribution of the wealth. It discourages hard work, provides no incentive to save and encourages the large scale consumption of goods. In other words, if you know that your money will be taxed at your death instead of it being passed on, why not simply produce less or spend a large portion of your wealth?
Additionally, those with taxable wealth will spend large sums on professional advice and assistance to maintain and preserve their wealth for future generations. These individuals will utilize a variety of tax avoidance devises and wealth transfers during life to minimize, if not avoid, the tax altogether.
Would a reduction in the incentive to make charitable contributions through the estate tax dramatically harm charitable institutions? There are still incentives through the income tax system to make contributions and receive favorable tax treatment.
Further, many donors do not take advantage of the charitable deduction at death by leaving vast sums to charitable organizations.
Tax treatment may affect the timing of a gift to charity but not the overall lifetime amount. Those who are charitably inclined will give and those who are not, won’t.
As to lost revenue it is important to recognize that the federal estate and gift tax revenue accounts for only one to two percent of the overall revenue raised in a given year.
Other arguments against the tax:
The imposition of a tax upon the transfer of wealth is potentially harmful to economic growth. The estate tax scheme encourages the shifting of resources from productive uses into tax-friendly uses.
For instance, assets could be allocated to enhanced business opportunities and expansion of existing business. The wise option may, in the alternative be, to invest those same resources into life insurance or private charitable trusts.
This tax exacts a high toll on family businesses. Family-owned and operated businesses are hit hard by the federal estate tax. While some limited tax relief permits estate tax to be paid in installments and affords special valuation rules, there’s still no question that the estate tax burden can force a sale of a family-owned business or farm.
This not only harms the family that must sell the business or the farm, but also the workers who lose their jobs when small-sized businesses are liquidated to pay estate taxes.
Tax reform will continue to be a hot topic on the political scene in 2000 and many proposals will be offered during the upcoming campaigns. The Estate and Gift Tax will be one of those considered for reform or elimination. There are pros and cons, but no easy answers.
Linda E. Wasielewski is an attorney practicing in Traverse City. Her practice focuses on estate planning, business planning and probate matters. BIZNEWS