The United States Death Tax

Abstract

The United States death tax originated in 1916 and has been reformed many times throughout the years. Over the last 100 years, 2010 was the only year in which heirs to an estate did not have to pay the dreaded death tax. However, repealing the death tax indefinitely is often a “hot topic” in politics.  Advocates of the death tax argue it is essential to the U.S. economy because it brings in an additional source of revenue, does not affect most Americans, and if repealed, would damage the U.S. economy and society. On the other hand, opponents of the death tax argue that it double taxes income, puts a financial burden on small business owners, punishes success, hurts the U.S. economy, and affects the lower class. President Donald Trump is among the majority of Americans that are against the death tax. He has referred to the death tax as “horrible” and “a disaster” and plans to repeal it immediately. However, since he has yet to provide many details regarding the repeal of the United States death tax, the future remains a mystery.

Keywords: death tax, estate tax, inheritance tax

The United States Death Tax

It has long been said that the only things in life that are certain are death and taxes. Today, in 2017, this still remains true. However, while death will always be inevitable, the future of the death tax is actually unknown. Since the death tax is one of the most despised taxes by the general public, it is often a major topic included in tax reform discussions. Additionally, with the election of Donald Trump, along with Republican control of both the House and Senate, there has been extensive talk about abolishing the death tax. The objective of this paper is to describe and provide a better understanding of the United States death tax. First, I will introduce and describe the death tax. Then, I will explain its background and history. Next, in the third and fourth section, I will provide arguments for and against the death tax, respectively. In the fifth section, I will address the death tax’s current status and future outlook. Finally, I will end with a conclusion that reiterates the most important points of the paper.

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What is the Death Tax?

The term “death tax” refers to both the estate tax and inheritance tax. The term is used in the Internal Revenue Code but is also said to be used by critics to describe the U.S. federal estate tax in a way that conveys a negative connotation. Note, although the terms estate tax and inheritance tax are often used interchangeably, they are actually two distinct terms with separate legal meanings. The United States Estate Tax is a tax on your right to transfer property at your death (I.R.C. Section 2001). For 2017, a filing of Form 706 is required for estates with combined gross assets and prior taxable gifts exceeding $5,490,000. Before the deceased’s assets can be passed on, the federal government taxes the fair market value of the assets at a maximum tax rate of 40%. The tax is paid by the estate itself. Thus, the estate tax is a tax on the total amount of the estate, after creditors are paid but before heirs get their bequest.

Conversely, the inheritance tax occurs after the heirs have received their payouts from the deceased. This is a tax, levied by some states, on the amount received and is paid by the heir. Since the inheritance tax is levied by a handful of states, it is possible for an estate to be taxed twice – first by the federal estate tax and then again by the state inheritance tax.  Inheritance tax rates vary from state to state, but tend to be set up on a progressive scale. Thus, the more valuable the estate, the higher the tax rate. Since not many states have an inheritance tax, the majority of this paper will focus on the Federal Estate Tax.

History of the Death Tax

The first federal estate tax law was part of the Revenue Act of 1916 which was passed during World War I to reduce the federal deficit (Shuster, 2001). It was originally enacted as only a “temporary” method to help fund the war. However, 100 years later, the federal estate tax law remains. When first created, this law taxed estates at a graduated rate from 1% on estates worth $50,000 to 10% on estates worth over $5 million (Luckey, 2003). Estates under $50,000 were exempted. Over the years, with the Great Depression and the outbreak of World War II, Congress was forced to increase the estate tax rate. In 1941, due to The Revenue Act of 1941, the top estate tax rate was increased to 77% (Luckey, 2003). As you can see in Figure 1, the estate tax, combined with the gift tax, has historically lingered between one and two percent of Federal revenue since World War II. However, there have been a few exceptions such as the 1930s when estate and gift taxes brought in much more revenue than normal.

The estate tax has been reformed several times. The most drastic change to the original 1916 law came from the Tax Reform Act of 1976. Among many other things, this act created a unified rate schedule consisting of a single graduated rate of tax for both the estate and gift taxes (Luckey, 2003). Historically, gift tax rates had been lower than estate tax rates which made it more advantageous to “gift” your wealth away during your life rather than pass it on to your decedents. This law eliminated the difference.

Another major change that affected the estate tax was the addition of the Generation Skipping Transfer Tax (GST Tax) in the Tax Reform Act of 1976. The GST tax is a tax on property that is passed down to a related person more than one generation younger than the donor, such as a grandparent leaving property to a grandchild. The tax is also assessed on property passed down through outright gifts or transfers in a trust to or for the benefit of unrelated individuals who are more than 37.5 years younger than the donor (I.R.C. Section 2651). Since the GST tax was created to ensure an inheritance is taxed at every generation level, it is only imposed if the transfer avoids incurring a gift or estate tax at each generation level (Johnson & Eller, 1998). Essentially, the GST tax ensures that grandchildren end up with the same amount of property that they would have had their inheritance been passed down through their parents instead of being passed down directly from their grandparents.

The next major tax reform was the Economic Growth and Tax Relief Reconciliation Act of 2001. During the 1990s, political and business support for elimination or reduction of the estate tax grew. As a result, during the 2000 presidential campaign, George W. Bush voiced his support for repealing the estate tax and even said he would sign legislation to do so (Shuster, 2001). Keeping his word, he signed the Economic Growth and Tax Relief Reconciliation Act of 2001 on June 7, 2001. This act made significant changes to the estate tax, gift tax, and GST tax. In general, it set a schedule for a gradual reduction, and eventual phase-out, of the death tax (Luckey, 2003). For example, the act led to the decline in the top estate tax rate from 55% to 45% by 2009. Furthermore, it increased the unified credit exclusion from $675,000 in 2001 to $3.5 million in 2009. In fact, this act completely repealed the estate tax and GST tax for the year 2010. Unfortunately, for the critics of the death tax, the Bush tax cuts included in this act had an expiration date. The tax rates were set to return to the pre-Bush tax rates after 10 years if Congress did not vote to extend them (Luckey, 2003).

Ten years later, under President Barack Obama, Congress successfully extended the Bush tax cuts for two more years. Then, in 2012, the Taxpayer Relief Act of 2012 was passed. This act resulted in a permanent exemption of $5 million, indexed for inflation, and a top estate tax rate of 40%. Today, the maximum estate tax rate remains at 40% and the 2017 exemption is $5.49 million.

Pros of the Death Tax

As mentioned, the United States death tax is one of the most loathed taxes by the general public. Even though this tax affects only a small percentage of U.S. estates, it has become a major topic in the political environment. Typically, Democrats see it as a populist measure designed to prevent the accumulation of extreme wealth, while Republicans complain it is a penalty on success (Edwards, 2016).

One of the arguments for the death tax is that it creates an additional source of revenue to finance government operations. Proponents argue that eliminating the estate tax would create a $269 billion federal deficit over the course of a decade (Edwards, 2016). While $269 billion represents a very small amount of total federal government revenues, that’s still a significant amount of money that would have to come from somewhere else. Ultimately, there is really no such thing as a “tax reduction.” If the estate tax is reduced or repealed, we will end up paying that tax somewhere else since we still need to pay for government services. Furthermore, if the tax is reduced or eliminated on the wealthiest Americans, then it will most likely fall, in another form, on less wealthy Americans. Many argue that that is unfair.

Another argument of proponents of the death tax is that most people are exempt anyway, and those who aren’t exempt, are typically wealthy so can afford to pay the extra tax. According to an article in Time Magazine, each year in the United States only 0.4% of decedent’s estates are subject to the estate tax (Edwards, 2016). This is because of the tax’s high exemption amount, which was $5.45 million per person in 2016. Because of this, the estate tax is best described as a tax on very large inheritances by a small number of wealthy heirs. If the estate tax was repealed, it would result in a huge windfall for those heirs. In addition, even the inheritance tax does not affect all Americans. As you can see in Figure 2, less than half of the states currently implement a state inheritance or estate tax, which leaves a lot of Americans unaffected (Ebeling, 2016).

Supporters of the death tax also argue that a repeal would damage the U.S. economy and society. As mentioned previously, if the estate tax was repealed, the heirs of America’s wealthiest families would benefit immensely while the majority of U.S. families would be hurt by higher taxes or cuts in vital programs such as Social Security, Medicare, or environmental protection (Shuster, 2001). The additional taxes or cuts in vital programs would be needed to make up for the lost government revenue from estate taxes. Furthermore, a repeal of the estate tax would give the implication that financial inequality in America is okay. Currently, the goal of the estate tax is to help keep the country’s wealth balanced because most people believe financial inequality is unlovely. Supporters of the death tax believe it is unfair for wealthy families to pass down their wealth to relatives without any consequences. They argue that passing down wealth discourages the heir from working hard and obtaining success on their own, which can be detrimental to the economy. Therefore, many supporters believe it’s philosophically and ethically right for governments to impose the estate tax on the wealthy.

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Another way the repeal of the estate tax could damage the U.S. economy and society is by weakening charitable contributions by the wealthy. Currently, wealthy families face a few options at the end of their life besides leaving inheritances to their relatives. In order to avoid tax consequences, they can either leave their property to their spouse or give it away to charity. Supporters fear that axing the estate tax will remove the financial incentive to give money away to charities (Edwards, 2016). According to Time Magazine, there is evidence that when the higher exemption rates for the estate tax were set to expire in 2013, charitable contributions from wealthy donors increased dramatically to approximately $440 billion in 2012 (Edwards, 2016). However, once President Obama and Congress agreed to extend the exemptions, charitable contributions fell to the normal annual rate of $30 billion (Edwards, 2016). When the wealthy realized they were going to have to pay a higher estate tax, because exemption amounts were decreasing, they made a monetary driven decision to give their money to charity rather than pass it on so they could avoid paying estate taxes. If the estate tax is completely repealed, then the wealthy would have no monetary incentive to give their money to charity rather than to their heirs. Hence, the fear of declined charitable contributions following the repeal of the estate tax is justified.

Cons of the Death Tax

On the contrary, over 70% of Americans actually support repeal of the death tax (Uhler, 2015). Critics of the death tax argue that it’s a form of double taxation, it puts a strain on small business owners’ ability to pass their business down to an heir, it “punishes” success and hurts the U.S. economy, and it actually affects the lower class more than the upper class. Traditionally, critics include Republicans, wealthy Americans, and small business owners.

Most taxpayers would agree that double taxation is unfair. I would even say that Congress believes this as well since there are many U.S. tax agreements and tax treaties in place to avoid double taxation between different countries, states, etc. Critics of the death tax argue that it double taxes income and thus, is unfair and should be repealed. In most cases, the assets in an estate have already been taxed. Some have even been taxed more than once. For example, income from capital investments is taxed at both the personal and corporate income tax level. However, according to the estate tax law, the assets are required to be taxed one more time before being passed down to the beneficiary. An estate tax will be implemented on the fair market value of the assets before the beneficiary receives them and will be paid by the estate. On the other hand, an inheritance tax will be applied when the beneficiary receives the assets and will be paid by the beneficiary himself. Either way, the assets will be double, and possibly even triple, taxed, thanks to the death tax.

Another argument of opponents of the death tax is that it places a significant burden on families that want to live the American dream of being successful by passing down a small business from one generation to the next. The estate tax is particularly harmful to families that own small businesses or farms because the amount of tax is based on asset value, but must be paid out of income. If these small businesses and farms lack the liquid assets needed to meet the federal government’s high death tax rate, then they are only left with a few options. This financial burden often forces many family businesses to be sold or closed upon the owner’s death. According to The National Retail Federation (NRF), the estate tax is “a major reason for the failure of small businesses” (Shuster, 2001). The article, “Death and Taxes” explains that “70% of family-owned businesses don’t survive into the second generation and 87% don’t make it to the third” (Shuster, 2001). Opponents argue that instead of punishing families for their hard work and success, the government should promote strong family businesses and entrepreneurs that contribute to our economy. In order to accomplish this, they believe the death tax should be eliminated.

As mentioned, the death tax is often viewed as “punishing” success. Not only does it place a significant financial burden on family businesses, but it also reduces the incentive to save and invest. Because the death tax falls on assets remaining after the owner dies, the owner might choose to not leave behind a lot of assets in order to avoid the additional tax. The decline in savings and investments reduce the nation’s capital stock and income which certainly hampers economic growth. According to The Joint Economic Committee, because of the reduced incentive to save and invest and the high compliance costs of the tax, the estate tax has reduced the nation’s capital stock by approximately $850 billion (Laffer, 2009). Furthermore, The Joint Economic Committee has also estimated that the death tax has deprived the U.S. economy of over $1 trillion in capital investments (Uhler, 2015). Clearly, this tax is hurting the U.S. economy. However, studies show that “repeal of the death tax would increase GDP by $137 billion a year, adding 0.8% to the U.S. annual growth rate. Additionally, it would create 150,000 new jobs every year and increase wages by 0.7% annually” (Uhler, 2015). Ultimately, federal revenues would increase considerably due to the economic growth and increased jobs and wages that would follow if the death tax was repealed.

The next key argument of opponents of the death tax is that it affects the lower class more than the upper class. Many people believe the death tax only impacts the wealthiest Americans, but that is not true. In reality, the death tax primarily affects those families that run small businesses and farms. The wealthiest Americans don’t always pay the death tax because they are able to hire lawyers and accountants who can help them avoid it (Uhler, 2015). “Many of the very largest estates are so tax-sheltered that the inheritances go to their beneficiaries having paid little or no tax at all” (Laffer, 2009). Unfortunately, the middle class, small businesses, and family farms typically do not have the capital outlay required to pay professionals to help them avoid the estate tax. Critics argue that it is unfair that the death tax, which is intended to tax the wealthiest, actually falls on well-meaning, hardworking, middle class Americans who just want to provide for their families. They also argue that the costs associated with the tax shelters and tax avoidance schemes exists solely to avoid the estate tax and are estimated to be as high as the total tax revenues collected from this tax (Laffer, 2009). Since costs to avoid the tax are approximately the same as the federal revenue brought in from the tax, the estate tax is often said to be one of the least efficient taxes.

Current Status of the Death Tax

The United States estate tax was created over 100 years ago and still remains today. For 2017, every person may leave or give away up to $5.49 million without owing any estate tax. For married couples, the surviving spouse has the opportunity to take any unused estate exemption left by the first spouse. On very large estates subject to the tax, the estate tax rate is currently 40%. However, as mentioned, with Donald Trump as the President of the United States, and Republicans controlling both the House and Senate, the future of the death tax is uncertain. Donald Trump has promised to eliminate the estate tax as soon as he can, but has yet to provide details on how he will pull it off. Will he offset the decline in estate tax revenue with an increase in capital gains? When will the repeal go into effect? These are questions most Americans are asking. The only response Americans have received from Trump so far is that he thinks the death tax is “a disaster” and needs to be repealed. According to his tax reform that will make America great again, the death tax punishes families for achieving the American dream and therefore, will be eliminated. If Trump keeps his word and repeals the death tax, the wealthiest Americans, including the Trump family, will be able to reinvest their billions. Stephen J. Entin, a senior fellow at the Tax Foundation, estimates that this could increase U.S. GDP by 0.7% over 10 years and significantly increase wages (Edwards, 2016). In addition, family businesses would be able to grow over multiple generations. In short, Donald Trump, with the support of 70% of Americans, believes that repealing the death tax would improve the U.S. economy. However, as of today, no one really knows if President Trump will stay true to his word and repeal the death tax. And if he does repeal the death tax, no one truly knows what consequences will follow and how they will be affected.

Conclusion

In conclusion, the death tax, which refers to both the federal estate tax and the state inheritance tax, has been around for many decades. Through the years, the original estate tax law that was enacted in 1916 has been reformed several times. However, one thing has remained the same: there are both supporters and critics of the death tax. Supporters believe the death tax is valuable for the U.S. economy because it provides an additional source of revenue, it does not affect a lot of people, and repeal would enrich heirs of America’s wealthiest families and weaken charitable contributions. On the contrary, critics of the death tax believe it is a senseless tax that is a form of double taxation, puts a strain on small business owners’ ability to hand down their business, punishes success and hurts the U.S. economy, and actually affects the lower class more than the upper class. These arguments have made the death tax one of the most hated tax in the country and a huge topic in politics. Over the past few months, because of the most recent presidential election, the death tax has been a popular focus of tax reform. President Donald Trump is an advocate for repealing the death tax and says it will be eliminated as soon as possible. However, months into his presidency, he has yet to provide information on how this will be done. For now, the future of the death tax is unknown.

References

• Ebeling, A. (2016, October 25). Where Not to Die in 2017. Forbes. Retrieved from https://www.forbes.com/sites/ashleaebeling/2016/10/25/where-not-to-die-in-2017/#4b27968d1e37
• Edwards, H. S. (2016, December 12). Why the Embattled ‘Death Tax’ May Not Be Long for This World. Time, 188(24), 28.
• I.R.C. Section 2001.
• I.R.C. Section 2651
• Johnson, B.W., & Eller, M.B. (1998). Federal Taxation of Inheritance and Wealth Transfers. Internal Revenue Service. Retrieved from http://www.irs.gov/pub/irs-soi/inhwlttr.pdf
• Laffer, A.B. (2009, April 02). Spend It in Vegas or Die Paying Taxes. The Wall Street Journal, p. A.19.
• Luckey, J.R. (2003 April 09). A History of Federal Estate, Gift, and Generation-Skipping Taxes. Report for Congress.
• Shuster, W. G. (2001). Death and Taxes. Jck, 172(7), 94.
• Uhler, L.K. (2015, April 15). Time To Bury The Death Tax. Investor’s Business Daily, p. A15.

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