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Inheritance Taxes

Copyright © 2004, 2007, 2012, 2016 by David E. Ross

… in this world nothing is certain but death and taxes

Benjamin Franklin, 1789

Inheritance and Taxes: Some Philosophical Comments

Neither God, the United States Constitution, nor the traditions of common law granted anyone the right to inherit wealth created by anyone else. Yes, we have the legal right to create wills and leave inheritances. However, only those we choose as our heirs can receive a bequest. I can indeed leave my entire estate to the local public school system, the public library, or any other government agency. I can leave it to a political party, the ACLU, PFLAG, or any other social action organization. I can leave my entire estate to the congregation where my wife and I have been members for over 35 years, to the Jewish Home for the Aging (which took excellent care of my mother), or to any other religious organization. I can leave it to my neighbor, with whom we have shared joy and grief for more than 40 years. In all of this, I can choose to exclude my descendents, who have already inherited some of my genes, my sense of ethics and integrity, and my passion for justice. The only person I cannot exclude from part of my estate is my wife, because of community property laws.

The DuPonts might believe themselves perceptive in observing the debilitating effects of food stamps for the poor, but were themselves living off a boundless supply of privately funded food stamps … The idea that you get a lifetime of food stamps based on coming out of the right womb strikes at my idea of fairness.

Without the estate tax, you in effect will have an aristocracy of wealth, which means you pass down the ability to command the resources of the nation based on heredity rather than merit.

Warren Buffet

Our system of laws is derived from the English common law. In England prior to the time of the American Revolution, it was not unusual for the King to seize the estate of someone who died, effectively levying a 100% inheritance tax and disinheriting the decedent's family. While other abuses of the English government were addressed in the U.S. Constitution, that abuse was not prohibited except as a punishment for treason.

Calling it the death tax is a political ploy divorced from reality. Our government does not tax the death of a person (except to levy sales taxes on the casket). It taxes the transfer of wealth from one person to another, in the exact same manner that a gift is taxed before the death of the person making the gift. And the tax is not levied on wealth transferred after death to a religion or charity.

Why should men leave great fortunes to their children? [If it is from affection, then it is a misguided affection because] great sums bequeathed often work more for the injury than the good of the recipients … It is not the welfare of the children, but family pride, which inspires these legacies.

The man who dies … rich dies disgraced.

Andrew Carnegie

A person intelligent enough to accumulate significant wealth should also be intelligent enough to own sufficient life insurance to cover all costs of his or her death, including the costs of inheritance taxes. When I hear complaints about inheritance taxes causing the loss of a family farm or a family business, it is usually expressed by someone who owns neither. The complaints are more likely to occur from some greedy individuals who anticipate being heirs. It's not good enough that they will receive part of a bounty for which they did not work; they want to receive it all.

Reform

The following presentation addresses three goals:

Estate Tax

When a person dies, the value of the estate should be determined as of the moment just before death. Thus, the estate might include the cash value of life insurance policies but not the amount of life insurance paid to beneficiaries (even if paid to the estate). The estate might also include payments already due under an employment contract but that lapse on death and will thus not be paid.

Subtract $2,000,000 from the total value of the estate. This reflects the fact that many middle-class families who have both a house and retirement savings might be worth more than $2,000,000. Also subtract any bequests to tax-exempt charities and religions. Finally, subtract all debts that will be discharged when the estate is settled. Whatever remains would then be subject to a 10% estate tax before any bequests are paid to heirs.

Gift Tax

This includes a tax on inheritances that would be levied in addition to the estate tax. That is, an inheritance should be treated as a gift. A person would be limited to giving or bequeathing $100,000 to any one other person tax-free; this would be a life-time limitation. Gifts and bequests would be added together, and there would be no additional annual amount exempted from the gift tax. Thus, if Emily gives George $60,000 during her lifetime, George can inherit an additional $40,000 tax-free from Emily on her death.

Any cumulative gifts and bequests beyond $100,000 from one person to another specific person would be subject to a 35% gift tax. This would be levied against the person making the gift or the estate paying the bequest.

Child Exception: Gifts from a living parent to a minor child would not be subject to the gift tax or count against the $100,000 limit until the total amount reaches $500,000. Once that $500,000 limit is reached or a child becomes an adult, gifts from a parent would be treated the same as gifts between any two other persons. Even for a minor child, a bequest from a dead parent would be subject to the gift tax.

Spousal Exception: For a couple married at least one full year, the limit would be $1,000,000 instead of $100,000. However, if the spouse making the gift or leaving the bequest received a gift or inherited a bequest from a prior spouse, the limit would be reduced by half of that earlier gift or bequest; the limit would not be reduced below the standard $100,000. That is, if Bob inherited $3,000,000 from Alice (his first wife), he can then give or bequeath only $100,000 tax-free to Carol (his second wife). If Bob inherited $750,000 from Alice, he can still give or bequeath $625,000 tax-free to Carol ($1,000,000 minus half of $750,000).

Community Property

The concept of community property should be applied uniformly across the U.S., not merely in community property states but in all states. Community property assumes that what one spouse earns during marriage is jointly owned with the other spouse. Half of all wealth accumulated during marriage would not be subject to the estate tax and would go to the surviving spouse without being considered part of a gift. The other half, however, would be part of Bob's estate for the estate tax and would be fully subject to the gift tax provisions.

When there is a divorce or dissolution of marriage, alimony and support payments are not gifts. They are deductible from taxable income by the ex-spouse making the payments and are taxable income to the recipient. A division of property is also not a gift, merely reflecting the concept of community property.

Even in community property states, inheritances and gifts are separate property, not shared community property. The same is true of assets owned before marriage. This should be reflected in the application of gift taxes when a surviving spouse remarries and then wills inherited assets to the new spouse.

It is possible to transform separate property into community property and vice-versa. Thus, this reform must address that situation. Deference should be made to the laws of the state where the married couple last resided if that were a community property state. Otherwise, the Internal Revenue Code should represent a harmonization of such laws for other states. In any case, a transformation would represent a gift of half the transformed property.

Trusts

The use of trusts and other estate-planning tools should not be prohibited, but they should be transparent to the estate and gift taxes.

Step-Up in Value

Today, this is a significant difference between a gift and an inheritance, best illustrated by example. Suppose you bought 100 shares of the PDQ Company eight years ago for $25 per share, an investment of $2,500. With splits and a good business plan, the stock is now 400 shares at $30 per share, worth $12,000; soon it will be worth $13,000. Under the current Internal Revenue Code:

In either case, your daughter's holding period began when she received the stock.

The reforms here are intended to equalize gifts and inheritances. Therefore, in either case, the basis should be the same: the average between the original basis and the value at the time of the transfer. In the above example, the daughter's basis would be $7,250, the average between $2,500 and $10,000; and her gain would be $5,750.

Because of the change proposed for the holding periods for capital gains taxes, this too can be significant for a gift. Stock that was bought eight years ago could be sold with only half of the gain taxed under that proposal. If it were bought ten or more years ago, the entire gain would be tax-free. While the goal here is to address the problem of accumulation of wealth, it is indeed unfair to suddenly eliminate an advantageous holding period. Thus, on a gift of non-cash assets, the recipient's holding period is reset to one-half of the previous holding period. In the example with the PDQ stock, your daughter's holding period began four years ago, reflecting your purchase eight years ago.

Note: This step-up of the value and redetermination of the holding period do not affect the gift tax itself at the time of transfer. They only affect the capital gains tax treatment of the gift if it is later sold. The value of a gift relative to exemptions and the gift tax is the value at the time of the transfer.

Substantially revised 21 October 2007
Updated 9 April 2016


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