Estate (or death) tax situation deserves careful scrutiny

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Published: April 25,2005

Should death be a taxable event?

The estate tax has been on the books for generations and generations. Theoretically, it prevents the wealthy from passing on their fortune to their heirs, who presumably have done nothing to earn or deserve it, tax-free. The tax was enacted to break-up old family dynasties, redistribute the wealth and give the rest of us a chance, through the sweat of our brow, to accumulate our own fortune. Critics have long claimed that the tax does no such thing and is merely another source of government revenue, and an immoral one at that.

Tempers flair and the debate goes on.

Early in President Bush’s first term, the Congress passed a bill that gradually reduced the impact of the estate tax over a 10-year period by increasing the exemption amount. The problem with the bill from day one was that, at the end of the phase-down period, around 2010, the tax goes back like it was before the bill was passed. Ouch!

Thus, a wealthy person dying in 2010 would owe no tax; however, should the person live just a few minutes beyond New Years’ Eve, the estate would be burdened with a big old juicy estate tax. It’s enough to tempt a loving relative into switching off the old guy’s life support just before midnight to beat the tax. Now, that’s tax planning taken to the extreme!

Ending the estate tax

Naturally, the assumption all along was that the estate tax would be abolished completely before its reincarnation in 2011. On April 13th, the U.S. House of Representatives passed a bill that would do exactly that, abolish the estate tax entirely, forever. At the time of writing, the Senate had not considered the bill and the game is probably far from being over.

Good tax? Bad tax?

Nonetheless, it might be interesting to debate the pros and cons of the estate tax. Obviously, the proponents of the tax consider it improper for rich folks to pass along their fortunes to their heirs without the public treasury taking a bite. Otherwise, fewer and fewer people would control more and more of the wealth. Also, as the theory goes, the beneficiaries didn’t do anything to create the wealth and have no more claim to it than the average American. And, in this corner, representing the “average American,” we find the federal government ready to step in and right this apparent wrong by taking a chunk of the inheritance for the public good.

A word of caution is in order at this point. The super-wealthy have found legal ways to skirt the tax for the most part, using generation-skipping trusts and other similar tax strategies. Case in point, everyone knows that Sen. Edward Kennedy has never worked a day in his life because his family left him, his brothers and sisters and all their children with enough money to allow them to devote all their time to public service. Somehow the estate tax didn’t break-up the Kennedy fortune as proponents of the tax allege that it does.

On a final note favoring the tax, charities benefit big-time from the death tax since money left to charity is deductible in computing the estate tax. Thus, with no tax to motivate, charitable organizations like hospitals and universities could suffer severe financial loss. This may not be sufficient justification for keeping the tax; however, it is worthy of note.

Now, on to the arguments against the estate tax. Well, it’s pretty obvious that many folks believe taxing death is unseemly. Kick a fellow when he’s down (literally!). Aside from the draconian implications of death being a taxable event, there’s the theory that, “I earned it and I should be able to do anything I want with it when I’m gone. I worked hard and took huge risks when average Americans were watching soap operas on TV and cooking hotdogs in the back yard, and I’m entitled to leave every nickel to my family.”

One pass is enough?

Well, so much for the emotional opposition to the tax. Another, perhaps more valid, consideration is the fact that the wealth was subjected to the income tax while it was being accumulated and one pass through the tax system is enough.

Though generally believed to be true, that supposition actually isn’t entirely true. Capital gains are not taxed until the property is sold, and thus the appreciation in value passed on tax-free through an estate has not been subject to the income tax.

One possible solution would be for capital gains to be taxed when the beneficiary eventually sells the property; however, this would create a paperwork nightmare. Beneficiaries would be required to have records detailing how much the decedent paid for the property and pass this information down generation after generation until the property was finally sold. Though pretty impractical, this will probably be part of the law if the estate tax is abolished.

So, there you have it. “It’s mine and the public has no right to it” versus “you didn’t earn it and the public has a right to eat at the feast when you die.” With the mood of Congress turning more and more conservative with each passing day, I suspect the estate tax will be repealed with some provision for taxing capital gains as part of the deal. Since the estate tax didn’t break up the Kennedy fortune anyway, we might as well let it go.

Thought for the Moment

It is not who is right, but what is right, that is important. — Thomas Huxley (1825-1895), biologist and educator

Joe D. Jones, CPA (retired), is publisher of the Mississippi Business Journal. Contact him at cpajones@msbusiness.com.

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