The federal estate tax, referred to as the “death tax” by opponents, looks again to be on the chopping block. President Donald Trump, in his tax proposal, has planned its demise.
“To protect millions of small businesses and the American farmer, we are finally ending the crushing, the horrible, the unfair estate tax, or as it is often referred to, the death tax,” Trump said in September. “The farmers in particular are affected. They have wonderful farms, but they can’t pay the tax, so they have to sell the farm.”
A repeal of the estate tax makes sense from “a pure economic analysis” as one could argue it would increase savings and capital, leading to more investments, especially for small businesses, said Sergio Santamaria, president of the CFA (Chartered Financial Analyst) Society Arkansas and finance professor for the University of Arkansas.
However, if it is repealed, the overall impact on the economy and investors would likely be “negligible” as only 0.2% of taxpayers (two out of 1,000) are subject to the tax.
“Moreover, the Tax Policy Center estimates that, out of the nation’s 5,200 estates that will owe any estate tax in 2017, only 50 will be small business and small farm estates,” Santamaria said.
Yet, Trump could cut his tax bill by about $1.1 billion if the tax were eliminated, according to a New York Times analysis. The analysis was based on Trump’s 2005 federal tax return, showing he had $2.86 billion in assets. Trump would still face New York estate taxes.
ESTATE TAX DETAILS
Historically, estate taxes have been established and repealed before and after wars as a means to pay for them. The modern estate tax, which was established during World War I, has been modified over the years, and in 2010, was repealed before being reinstated the following year. Whether it’s repealed again, the tax could come and go with the changing administrations, and if it does, some wealth managers caution investors to refrain from making changes in investment strategies related to the tax.
When one dies, a 40% tax is placed on the deceased’s estate for the portion worth more than $5.49 million for individuals and $10.98 million for couples. A married person who dies with a business worth $15 million would owe $1.608 million in estate tax. The estate tax is paid when the estate tax return is filed, said Erik Berry, partner at WealthPath Investment Advisors in Rogers. The estate tax return is due nine months after the date of death, according to the Internal Revenue Service. A six-month extension is available if requested before the due date.
Those who pay the tax are the “most complicated people on the planet,” Berry said. “They may own multiple businesses.”
Some people aren’t aware it exists, he said. The estate tax return is a complicated process, and the heirs of the estate might still be grieving when the due date for the return arrives sooner than anticipated.
Its repeal would help family-owned businesses, such as a family-owned farm, possibly one the heirs weren’t aware was worth so much, and they might be required to have a “fire sale on the property” in order to cover the tax burden, said Clay Kendall, partner at WealthPath. One who has prepared for the estate tax might purchase a life insurance policy to cover the tax.
“Life insurance is tax free,” Kendall said.
Yet, if the estate tax were to be repealed, this might start a trend of people dropping life insurance policies. However, uncertainty is the problem, Berry said. The estate tax might be restored in four years, under the next administration.
“You might live another 30 years,” he said. And, the policy that was dropped might not be restored so easily, especially if one has developed a health issue, such as cancer, since it was dropped, Kendall said.
When asked if investor behaviors would change as a result of a repeal, Santamaria said most investors wouldn’t change “materially their investment decisions based exclusively on the estate tax.”
But the overall tax reform that Trump has proposed, including “permanent reductions in both corporate and individual tax rates as well as a repatriation tax break, might have a strong positive effect in the overall economy and consequently in investors’ wealth planning,” Santamaria said.
“A significant part of the ‘Trump’ rally that has pushed the S&P 500 and other equity indices to historical records since last year’s election, is due to an anticipation of a comprehensive tax reform but not particularly to an expectation of estate tax repeal.”
James Bell, vice president of Garrison Financial Corp. in Fayetteville, said an estate tax repeal might affect a “handful of clients.” But there are multiple strategies to avoid paying it, such as giving gifts of up to $14,000 annually per person “without triggering gift taxes.” Others include paying their children’s medical debt or education. Bell explained when Congress approves a tax cut it must be revenue neutral, meaning the government has to cut spending by an equal amount.
Along with repealing the estate tax, Trump also wants to repeal the generation-skipping transfer tax or GST. But his tax plan doesn’t include a repeal of the gift tax, which applies to transfers one makes while living. During his campaign, Trump and members of Congress wanted a repeal of the gift and estate taxes. The Congressional Budget Office projected the taxes would raise $271 billion in fiscal years 2018 through 2027.
In a letter to Congressional leaders, the Family Business Coalition, along with nearly 150 other organizations, supported the repeal of the estate tax, citing it would “spur job creation and grow the economy.”
However, the Patriotic Millionaires, in a letter to Trump and Congress signed by more than 100 people who qualify for the estate tax, want to see the tax retained, noting that it was introduced “a century ago when economic inequality had reached such historic levels that it was considered a threat to national stability.” The benefits of repeal “would go almost entirely to people at the top of the income distribution and would invite significant sheltering of income,” according to the Tax Policy Center.
“Further, gifts from an estate to charity currently qualify for full deduction from the estate’s taxable value, creating a substantial incentive to leave bequest to charities.”
An estate tax repeal was projected to reduce charitable donations by 6% to 12%.
“The idea of no estate tax will be great,” said Rogers attorney Chris Rogers, member for the law firm Mitchell Williams. But the likelihood for repeal is not, as it might be the “first thing off the table” when negotiating for broader tax reform.
Also, the Senate would need a 60-vote majority for repeal without a 10-year sunset to avoid the same fate as the Economic Growth and Tax Relief Reconciliation Act.
“In today’s environment it would be difficult to get a 60-vote majority,” Rogers said.
ESTATE TAX HISTORY
A tax on the transfers of property to heirs can be traced back to ancient Egypt as early as 700 B.C., according a history of the tax on the IRS website. Almost 2,000 years ago, Roman Emperor Caesar Augustus imposed a tax on “successions and legacies to all but close relatives.” In feudal Europe, taxes were common when a family member died, sometimes the cost of a family’s annual property rent.
In 1797, during a conflict with France, U.S. Congress raised money for a Navy by imposing a stamp tax. Federal stamps were required on wills, inventories of a deceased person and “receipts and discharges from legacies and intestate distributions of property.” In 1802, the tax was repealed after the crisis ended.
In 1862, the federal government established a death tax to raise money during the Civil War. It was similar to the stamp tax of 1797 but also included a legacy or inheritance tax that was applied to personal property and was based on the relationship to the deceased, not the value of the estate. In 1864, as the cost of the war rose, a succession tax on real estate was added, taxing the transfers of real estate, according to the history. By 1872, the taxes, which had contributed $14.8 million to the federal budget, were repealed.
In 1898, as a means to pay for the Spanish-American War, a federal legacy tax was adopted. It was similar to the modern estate tax in that the tax rate was based on the size of the estate, along with the relationship to the deceased. The tax was repealed in 1902 after raising about $14.1 million.
In 1916, the modern estate tax was established on the “transfer of wealth from an estate to its beneficiaries,” according to the history. In 2001, Congress approved the Economic Growth and Tax Relief Reconciliation Act, which led to the repeal of the estate tax. But the act expired in 2011, and the estate tax was restored.