Why is an estate tax constitutional?

Great Debates
21

I agree with Spartydog that the OP’s premise (that the estate tax is not a tax on heirs) is just flat out wrong. There’s nothing wrong with taxing a transfer of money, and as it turns out, for the vast majority of people, the estate tax is a massive tax benefit not burden. Spartydog got part of the way there by pointing out that absent the estate tax we should tax inheritances as income, but that’s not even the biggest aspect of the shelter. That prize goes to the cost basis step-up. Let me explain.

Person A buys $100,000 worth of stock, and sees it appreciate to $3M over the course of his lifetime. If he were to sell that stock and then bequeath the proceeds to his heirs, he would be taxed on $2.9M in capital gains (call it 20%, if A sells after 2011), which is $580K. But suppose instead he just lets his heirs inherit the stock itself. The heirs pay no tax, as the estate is less than $3.5M. Now things get magical: the cost basis of the stock goes up to $3M, so if his heirs immediately turn around and sell the stock, they pay no taxes at all. The entire capital gains of A’s stock have been shielded from tax liability.

What people forget is that the estate tax hits the entire estate, which includes things like unrealized capital gains that have not yet been taxed. Arguing to eliminate the estate tax is arguing to allow huge quantities of money (e.g., the Walton estate, much of which is tied up in stock that represents unrealized capital gains) to be made absolutely tax free. The Walton heirs would never be double taxed on their inheritance; eliminating the estate tax means they won’t be taxed at all.

22

Not really. The same dollar isn’t taxed twice – fed and state taxes are aggregated, but they come at the same time. And of course you typically get a state tax credit for what you paid in federal income tax, so it’s actually even less.

That’s better understood as a component of cost, not a tax on your earnings, but OK, fair enough. If you buy things. But if you’re wealthy, and you buy a lot of securities, you don’t pay tax on them. So this is one of a million ways in which the tax burden falls unfairly on the poor.

Ooh, yeah, that’s a scary “etc.” But it’s empty – you missed “boats.” Other than that, what else has continuing property taxes? Pretty much nothing. And while real property is high-value, the nominal tax rates on it are usually rather low, while the actual rate is much, much lower because most jurisdictions don’t actually tax property on its current value when it appreciates. But when you sell it, or borrow on it, that’s all forgotten.

In what way is this a tax on your first dollar? In no way at all. You’re taxed on the appreciation when you sell something – the price you paid (the “basis”) is deducted from the price at which you sell, and you pay no tax on it, precisely because we understand that you already paid your taxes on that part of the sale price.

You must be filthy rich then, I guess. Certainly, if you’re one of the very few who have enough wealth to pay the estate tax, you can afford to hire a fucking accountant to avoid most of it.

Bull. Shit. They pay not one penny of tax. They don’t pay income tax on inheritance – it’s tax free. But if they buy something with it and later sell for a profit, they still get to exclude their basis, even though they didn’t ever pay tax on the basis. (Oh, but if their dad was rich enough to pay the estate tax, they probably do own a yacht or three – so fair enough, there is one tiny piece of tax they may have to pay.)

If you’re going to rail about how unfair the tax system is, you should probably understand something about it first.

Why are bridges falling down and sewer systems overflowing? Because no one has done public works maintenance for 25 years – whenever there’s a little excess money in the state budget, the public demands tax cuts instead of actually using the money for needed services. Why is the air being fouled and the global temperature rising? Because no one is willing to pay a tax on carbon, even though we all know it’s going to ruin the planet. When the robber barons were around, the highest income tax bracket was between 79% and 91%. And yet they managed to make fortunes so astronomical that their descendants are still living on their inheritances half a century later. You drive on the roads. You use the hospitals. You post on the Internet, fer crissake. You think all that stuff appeared by magic?

–Cliffy

23

Except that “within the framework of the law” is not always clearly defined (at least according to my tax adviser). If the govt. appears to be playing fairly, I will stay away from anything that might be shady. On the other hand, if the govt wants to play rough, I’m more likely to tell my tax person to go all out.

24

Well, there are some things that haven’t yet been ruled on, and there are some of those in which there is a genuine question of which way it’ll come out (though most of those are not relevant to individual/small business taxation.) I’d only call the second category things that aren’t yet defined as within or outside the law. **But that doesn’t mean that they are legal–it means you don’t know if they are legal or not. **

Further, a court will be happy to decide whether they are legal or not–all you have to do is to take such a position, and wait for the IRS or the state tax authority chooses to contest it. If it’s within the law, you’ll win. If it’s outside the law, you’ll lose. (also, at least for some arguments that are unlikely to succeed, your tax adviser is ethically obligated to disclose that you are using the argument on your tax return–so the IRS will find out if you’re trying something really extreme).

It seems obvious to me that if you take a position without being certain what its tax treatment will be, you do so at your own risk. If you’re willing to play “hardball” by doing things without knowing if they’re illegal or not, it’s your choice–and your problem if they fail.
IANAL, and none of this is tax/legal advice. You’d be crazy to rely on something on an anonymous message board.

25

The first estate tax was passed with the Stamp Act of 1797, and the Speaker of the House at that time had been a delegate to the Constitutional Convention. This suggests that it wasn’t blatantly unconstitutional, at least.

26

I’m tired of people making this mistake. The estate tax rate is a MARGINAL rate, meaning that the current 45% marginal tax rate only kicks in for amounts over the current threshold amount of $2M. That means that the first $2M passes completely free of any federal estate tax. If a person’s taxable estate is $3M, the tax is 45% *(3M-2M)= 450,000, which means that the effective rate of the tax is 15%, or 450,000/3M, leaving the estate with the still tidy amount of $2.55M.

27

If you think this is the case, I’d like to see the provision you think says this is true.

Actually, I’ll save you the trouble: there is no such provision. The people that wrote the Constitution had no intention to eliminate taxation. Their famous rallying cry in the Revolution was not “no taxes,” it was: “No taxation without representation!” It’s hardly a technical distinction. They were quite aware of, and supportive of, the reality that a government needs revenue supplied by its citizens. They objected to having a government take monies from its citizens while denying those citizens a voice in the government.

(Note that in this historical context, “citizens” means white, free, male, land-owners.)

From the start of the colonization of North America, taxation was a recognized power of government. The very first written constitution for any English colony, the Fundamental Orders of Connecticut gave the General Court (i.e. the state legislature) power to levy taxes from the towns:

The Articles of Confederation put essentially no barriers on these states’ ability to collect taxes. When the Articles of Confederation collapsed, one of the reasons was that the federal government had no power to levy taxes; it could only request money from state governments.

The Constitution, far from saying “the government [isn’t] supposed to take your stuff” was in part written specifically to give the federal government the power to tax.

Why, with that history, would any person think the Consititution puts barriers in the way of taxation? Oh, that’s right, because they don’t like paying taxes. Well, I hate to say, but disliking something does not make it unconstitutional.

28

Estate taxes are only applied to estates over $7 million. Hard to work up too much sympathy for someone who is just slavering to get their hands on a windfall like that. I say eat the rich.

29

Question: if a person dies with 18 million dollars and is leaving it to three heirs, so they each get 6 million (under the 7 mentioned above), does the state get any money?

30

The estate is what is taxed, not the distributions. Receipt of inheritance is not taxable as income.

The estate is valued at 18 million. That is what is taxed.

(p.s. it’s only 7 million because each spouse/parent gets 3.5 million in estate tax exemption. so when mom dies, instead of having all of her assets transfer to dad (which is always tax free - intraspousal transfers are tax free) she transfers 3.5 million tax free to kid. then, when dad dies, he transfers his 3.5 million tax free. if mom transfers it first to dad, then dad can only transfer 3.5 of the 7 million tax free)

31

To support the troops?

32

You’re missing a bunch of taxes, there. Near as I can figure, every dollar you earn has been taxed somewhere between 1000 and 10000 times. You earn money doing work, and pay income tax on it. Then you take that dollar to Wal-Mart, and buy a Christmas present, and pay sales tax. Then Wal-Mart uses that money to pay the cashier who checked you out, and she pays income tax. Then she uses that money to pay her rent, and there might be a tax there. Then the landlord pays property tax on the apartment, and maybe buys some stock. The company he buys stock in pays tax on its raw materials, and so on. This is not robbery; this is an economy. Of course the same dollar keeps getting taxed, because it keeps getting circulated.

33

I’ve always loved Al Franken’s take on the estate tax which is roughly that it’s immoral because it puts a burden on the MOST productive members of society… the children of the extraordinarily wealthy.

34

but…but… but…they provide the capital investment to allow everyone else the opportunity to work!

35

Interesting.
In Canada, the estate is deemed to have been disposed at the time of death. You (your executor) don’t actually have to sell those Microsoft or Xerox shares you bought for $1 each, but you value them at fair market value as if you had soldthem for tax purposes. So all that increased value causes a capital gains tax which is paid out by the estate. There is no free re-valuation. Unless you plan ahead, or Junior has a lot of money or you left a lot of cash also, the executor may have to sell the cottage or the yatch to pay the tax bill.

Special cases- IIRC there’s a special provision for passing on the family farm without having to sell it to pay taxes; and in Canada, the primary residence is not subject to capital gains - but also, you cannot deduct mortgage interest from your taxes.

This interesting tid-bit saved Canada’s bacon in the recent mortgage collapse. Since there’s not tax incentive to keep your interest payments high, the general trend in Canada is to pay off the house ASAP. Not too many people remortgage to the hilt, so most houses are partially paid down and many are fully paid off.

Not sure if Canada still has an estate tax; if it does, it is also like the USA for significantly large estates.

I recall someone talking about leaving their vast fortune to charities rather than their kids; the guy sai something along the lines “I’ll leave them enough so they can do anything they want, but not enough that they can do nothing.”

I.m surprised the USA doesn’t have a revaluation at death for the estate. SOme rich guys got their money’s worth out of a bunch of lobbyists and congress-critters.

36

the same thing happens here. the capital asset isn’t sold, the basis is just modified.

37

Where is that? In the US, the assets aren’t deemed sold (so there’s no imposition of tax on gain)–the basis modification is free.

38

Isn’t that what I said?

Beneficiary receives capital asset at a stepped-up cost basis

Estate paid relevant taxes on that capital asset, if applicable.

39

The thing I was questioning was your statement that “the same thing happens here”–when replying to a post about canadian tax law.

It’s not quite the same–since the “relevant taxes” in the post you referenced (i.e. in canada) are capital gains, not estate taxes–and in canada, the tax is on the gain, not the value.

So in Canada (just based on the explanation of the law there in the post you quoted before I replied-IANAL, or ACL) if you have an asset with basis 10 and FMV 100, you are taxed on a gain of 90 at capital gains rate. In the US, the basis is stepped up, and if you’re liable for estate tax, you are taxed on 100. However, in Canada, if you have an asset with FMV and basis of 100, it looks like there is no gain to tax–whereas under an estate tax system, it would still be a taxable estate of 100.

40

Nice analysis. I never thought about this before.