Truths about the Estate Tax - Debunking the Popular Myths

Category: Estate and Inheritance Tax

In yesterday's post, Who Wants Estate Tax Repeal - The Uber-Rich Lobby (98%+ chance you aren't one of them) I highlighted a new report from Public Citizen and United for a Fair Economy that demonstrated how "18 families worth a total of $185.5 billion have financed and coordinated a 10-year effort to repeal the estate tax, a move that would collectively net them a windfall of $71.6 billion."

In the report entitled "Spending Millions to Save Billions - The Campaign of the Super Wealthy to Kill the Estate Tax" Public Citizen's Congress Watch and United for a Fair Economy explore and refute some common myths about the estate tax. These myths are just plain wrong "facts" that many believe to be gospel truth about the estate tax, but are, in real fact, just plain wrong. I thought the report did such an excellent job of educating readers about the true role of the estate tax, that wanted to highlight some of the information here. This is a long post, but it gets to the heart of the matter of the estate tax. The education it provides is worth scrolling down for.

From entitled "Spending Millions to Save Billions - The Campaign of the Super Wealthy to Kill the Estate Tax" (footnotes removed):

Myth: The Estate Tax Forces Families to Sell their Farms
Several years of investigative journalism articles and congressional reports have made it clear that the notion of any farm being destroyed by the estate tax is a myth. In 2001, the pro-repeal American Farm Bureau could not provide the New York Times with a single example of a farm having been sold to pay the estate taxes. A 2005 report by the Congressional Budget Office found that at the current exemption level of $2 million, very few family farms would owe an estate tax. If the $2 million threshold existed in 2000, as many reform proposals would have allowed, only 123 farms in the entire country would have owed estate taxes that year. The CBO study also found that among the very few that would owe taxes, the vast majority would have sufficient liquid assets (savings, investments and insurance) to pay the taxes without having to sell off any farm assets. For example, at the $2 million threshold, only 15 of the farms would have had insufficient liquid assets to pay.

Myth: The Estate Tax Destroys Family Businesses
Like the allegations about family farms, the notion that the estate tax forces family-owned enterprises out of business is equally fallacious.

Of the 2.5 million people who died in 2004, only 440 left a taxable estate with farm or business assets equal to at least half the total estate, according to the Tax Policy Center, a joint project of the Urban Institute and the Brookings Institution, and 210 of these owed less than $100,000.

Myth: Estate Tax is Double Taxation
Advocates of estate tax repeal claim that the estate tax is unfair because it taxes the same money twice: once when it is earned as income and again as part of an estate. But this reflects a misunderstanding of the tax structure and of what is actually taxed in most estates.

Money in our society is frequently taxed upon transfer, so the same dollar is often taxed more than once.

The reality is that the bulk of wealth in large taxable estates has never been taxed at all. This is wealth in the form of appreciated property, stocks, and bonds that have increased in value since they were acquired or inherited - and have never been taxed. Without an estate tax, billions of dollars of untaxed capital gains would pass within wealthy families without any tax.

In estates with assets over $10 million, over 56 percent of the wealth takes the form of appreciated property, stocks and bonds. As estate tax wealth exemptions rise, the tax will increasingly be levied on estates with higher percentages of appreciated property that has not been taxed.

Myth: It Costs More to Comply with the Estate Tax than the Revenue It Raises
Compliance costs include both the cost to the IRS of administering the tax and the personal costs of preparing tax returns, planning for the tax, and administering an estate.221 A 1999 study by two professors at Rutgers University concluded that the cost of estate tax compliance ranges from 6 to 9 percent of estate tax revenues. This is consistent with other forms of taxation, including the federal income tax. "The costs of administering the estate tax have been grossly overstated. We do not know why,"they wrote. "Instead of high cost, we find the estate tax to be an efficient tax."

About half the costs associated with estate taxation would remain even if the tax were repealed. Researchers Joel Friedman and Ruth Carlitz observe "activities such as selecting executors and trustees, drafting provisions and documents for the disposition of property, and allocating bequests among family members would still have to be undertaken in the absence of an estate tax."

Repeal advocates continue to propagate myths about costs of administering the estate tax. The Policy and Taxation Group's Center on Taxation and Policy publishes a list of "Reasons the Death Tax Does Not Work," which asserts that "it collects just 1 percent of the nation's revenues, and dollar for dollar, it costs as much to collect death taxes as it raises." Seattle Times publisher Frank Blethen, patriarch of the family that owns a majority interest in the Seattle Times Co., used his deathtax.com Web site to claim, falsely, that "it costs the government 65 cents of every dollar raised for enforcement and compliance."

Myth: The Super Wealthy Avoid the Estate Tax
There is a myth that the estate tax is "voluntary" for the super wealthy and that the people who pay the estate tax have small estates and less resources to hire planners. It is true that doing estate tax planning - such as planned giving to heirs - can reduce one's tax bill. This favors estates with greater liquidity of wealth.

But the super wealthy do pay significant estate taxes, under current law. In 2004, the 520 largest estates - those valued at over $20 million - paid a net average tax of $10.8 million each.

There are only three ways that super wealthy individuals can entirely avoid paying estate taxes at death;
* Pass all wealth above the given year's exemption level to one's spouse, taking advantage of the unlimited marital deduction;
* Give all wealth above the given year's exemption level to charity, thereby reducing one's estate; or
* Die in 2010, the only year that the estate tax is currently scheduled to be repealed.

Some people purchase life insurance in an amount sufficient to pay their estate taxes when they
die. This doesn't enable them to avoid the tax but, in essence, to pre-pay it through insurance premiums. This effectively shields heirs from having their inheritances reduced by the amount of estate taxes, while still providing for the tax itself to be paid in full.

Myth: The Estate Tax is Confiscatory Because it Takes over Half of Someone’s Estate
The top marginal estate tax rate in 2006 is 46 percent. In 2009 it will be 45 percent. But this rate applies only to amounts that do not go to a spouse or charity and that exceed the exemption. In 2006, only amounts higher than $2 million for an individual or $4 million for a couple will be taxed at that rate, and that's if no other spousal or charitable provision has been made. Therefore, a substantial portion of most estates is passed on untaxed.

According to IRS data, the "effective" rate - the percentage of estates that is actually paid in taxes - averaged about 19 percent in 2003, a year in which the top rate was 49 percent.