My understanding is that any tax on property is a direct tax and thus under the Constitution if the Feds implement a property tax must be apportioned to the states based on population. An estate tax is in effect a tax on a person’s assets when they die. According to the IRS “The Estate Tax is a tax on your right to transfer property at your death.” but a couple questions come out of this.
Can a right really be taxed? I guess so since poll taxes were legal until the 24th Amendment.
As applied, how is this different than taxing a person’s property? Let’s say Congress makes a tax on “the right to own a car” with the following limitations
a) Does not apply to people who do not own a car (but wait, they still have the right to own a car)
b) Owners with cars that cost under $35,000 are exempt (but wait they have the right to own that car)
c) The tax is proportional on the value of car prices over $35,000 - for example, a car that costs $45,000 has $300 in right-to-own-car taxes while a $55,000 car has $600 in right-to-own-car taxes. The second person does not have twice as much rights do they?
So just because the tax is called a right to own car tax it really is a tax on the property (car) itself and is a direct tax.
Did I miss anything? If not, how is the estate tax constitutional?
The estate tax is mostly a tax on unrealized Capital gains. Gains that have not yet been taxed.
But yes, the tax has been challenged and is legal: Amendment XVI Income Tax
*The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.
*
That seems to be the gist. A property tax is a tax on your property. You own your house, you pay the tax, you still own your house. A sales tax or income tax happens when you transfer ownership - and this is what happens during inheritance. Joe Sr. owned the house, dies, it transfers to Joe Jr., tax payable. Joe Sr. doesn’t die, no tax payable … yet.
I think we had a thread on this somewhere a little while ago…
The idea is that an estate tax is an excise tax – that is, it is a tax on the transfer of the estate. I think it makes some sense, but if you go back to the Supreme Court decisions dealing with estate and legacy taxes, much of the rationale is, basically, that we’ve always understood these taxes to be excise taxes (and not direct taxes).
As I understand it, it’s referred to as a tax on the right to transfer because the tax obligation attaches to the estate before the distribution. So, to use your car example, we routinely pay taxes upon the transfer of a car (usually by the receiving party). But if we call it a tax on the “right to transfer” your car, it would be paid prior to the transfer and by the transferor.
Also, although not directly relevant, a poll tax wasn’t a tax on the right to vote (I mean, it was, but not formally). A poll tax is a direct capitation tax (a fixed sum to be paid by an individual). It was widely used to fund the colonies. Some states made payment of the poll tax a requirement to register to vote, which had the intent and outcome of rendering poorer voters ineligible to vote. That was the point of the laws, of course, but a poll tax isn’t directly a tax on voting.
Legacy taxes predate the Sixteenth Amendment. Congress imposed legacy/estate/death taxes to pay for the Quasi-War with France (1797), the Civil War (1862), and the Spanish-American War (1898). Both of the later two taxes were challenged and upheld, the latter in the case of Knowlton v. Moore in 1900:
And also, quoting from an earlier case:
Again, all of this was before the Sixteenth Amendment.
So if it’s a tax on an estate, not the transfer - how does it escape tax (or some taxes?) by being moved into a trust instead of going to an heir? How does this loophole work?
I don’t know what “loophole” you’re talking about. But most of the trust-based estate planning methods that I am aware of working by either keeping money out of your estate (e.g., life insurance trusts) or moving money out of your estate while you are alive. The goal being that the value of the estate (as a legally defined term of art) should be as low as possible when you die.
I am aware of people setting up their will to leave everything to a trust which, in turn, has instructions to distribute the estate in a certain way (i.e., to your heirs). But my understanding was that the point of this was to get out of probate as fast as possible and give the beneficiaries more flexibility in the distribution of the estate. I don’t think it has tax consequences.
IANAL(BMFW)
The most common exception is generation skipping trusts. In the simplest form, the estate puts money into a trust which distributes income and finally distributes principal to the grandchildren That way the principal of the estate is taxed only once rather than being taxed when transferred to the children and then again when transferred to the grandchildren. You can’t go further than the second generation. (Though you can name specific individuals in later generations. See rule against perpetuities.)
You could also set up a charitable trust. Essentially paying your descendants charitable gifts now to escape estate taxes.
I looked this up earlier sorta as part of my job as a tax professional. As has been mentioned, it’s treated as an indirect tax because it is a tax on a transaction: passing wealth to an heir. It is not directly a tax on income or wealth, because if you give it all to a charity or government it doesn’t get taxed. Taxes on wealth are forbidden as direct taxes that are not apportioned by population, while income taxes were the same way until specifically allowed, but taxes on transactions were widely considered the main way that the government should be getting money, the transactions generally being importing and exporting, and were only indirect taxes on wealth.
When you put the money into a trust, it gets taxed as a gift. While the nominal tax rate (40%) is the same for estate and gift taxes, the effective rate is lower for gift taxes because the tax is only charged on the amount of the gift, not on the gift plus the amount of tax to be paid as is the case for estate taxes. If you want to give someone a million dollars as a gift, it’ll cost you $1.4m if you’re past the exemption amount. But if you’re past the exemption amount and die with $1.4m more than you planned, then the heirs only get 60% of that extra amount, which is $840k. So giving a death bequest costs you 16% (= 40% * 40%) of the amount that could have been gifted instead during your lifetime.
The money was transferred from a person to some other entity, be it real person(s) or a legal pseudo-person called an estate. That’s fundamentally different than a wealth tax where no such transfer takes place.
I’m not familiar with the second part of this expression.
Yeah, but that doesn’t change the tax liability of the original estate. Under a GST, essentially, the individual leaves his money to his grandchildren (and pays the estate tax that he incurs). Because his children never inherit, they don’t owe estate tax on that money. You do it in a trust for a variety of reasons, but in principal (when it comes to the estate tax) it’s not any different than leaving your estate directly to your grandchildren. That is, the estate tax is a tax on the estate (or the right to transfer the estate). It gets paid whether your transferring to you children, your grandchildren, or a trust (but not if to your spouse). The GST just means that some other people don’t pay estate tax on money they never had when they die.
Yes but with a trust you can leave the income to the children and the principal to the grandchildren with only one tax. Also, it doesn’t save taxes, but you can leave it to grandchildren not yet born with a trust.
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