How to Restore Taxes on Inheritances

AP Photo/Mark Lennihan, File

Since 2000, a growing number of wealthy U.S. nationals have deployed the offshore system and complex trusts to dodge estate levies and other taxes, including by Facebook founder Mark Zuckerberg, fashion designer Ralph Lauren, DISH Network Chairman Charles Ergen, and 84 current and former partners from Goldman Sachs, including CEO Lloyd Blankfein (pictured, above).  

This article appears in the Summer 2018 issue of The American Prospect magazine. Subscribe here

As part of the 2017 tax bill, Congress came within a whisker of abolishing the estate tax. In the end, Congress weakened the century-old levy on inherited wealth paid exclusively by multi-millionaires and billionaires.

The estate tax was one of the substantive negotiating points of the joint tax conference committee that reconciled the differences between House and Senate versions in December 2017. House Republicans, fulfilling a decades-old aspiration, voted along party lines to abolish the tax.

Senate Republicans were divided and several wondered aloud about the necessity of complete repeal. Arizona Senator Jeff Flake, in a moment of candor, pointed out that Congress had already “done pretty well” in modifying the estate tax. He questioned the GOPcontention that estate tax repeal would have a positive economic benefit, doubting “whether [repeal] stimulates that much more.”

At a pivotal moment, Senator Susan Collins of Maine and Senator Mike Rounds of South Dakota signaled their opposition to estate tax repeal. The Senate voted to double the wealth exemption but retain the tax.

The law that was finally enacted mirrored the Senate version. The amount of wealth exempted by the tax, minus deductions—such as for charitable giving—was doubled from $5.49 million for an individual to $11.18 million—and from $10.98 million for a couple to $22.36 million. The 40 percent rate remained unchanged.

Prior to congressional action, the estate tax was on track to raise $280 billion over the coming decade. After this reform, the tax is estimated to raise $32 billion less over the next decade, according to the Congressional Budget Office.

Like other provisions affecting individual taxpayers in the 2017 tax bill, changes in the estate tax will expire in 2025. Unless Congress acts, the wealth exemptions will revert to the 2017 law, with its $5.49 million individual wealth exemption adjusted for inflation.

Estate planners face interesting new scenarios—such as one spouse dying before 2025 under the new law and a surviving spouse living to see the law revert to 2017 rules. “The legislation is just idiotic,” said James Spica, an estate tax specialist in Detroit. “You’ll get half the benefit if the second spouse dies outside this new regime.”

While the estate tax appears to be on life support, it is surprisingly resilient. While the tax has been under attack for decades, it already survived a near-death experience in 2010.


Looking Back

The estate tax has been in GOPcrosshairs since the late 1990s, when a number of conservative anti-tax organizations, such as the Family Business Coalition and a cabal of wealthy newspaper owners, mounted a full-frontal assault. At that point, the amount of wealth exempted by the tax hovered around $675,000, it was paid by about 2 percent of estates, and it raised about $38 billion a year in current dollars.

Estate tax opponents spent millions to save billions. The levy triggers intense opposition from those fortunate enough to be subject to it—the wealthiest 1 percent—who obviously have plentiful resources to fight it. In the early years of opposition, 1997 to 2005, dynastically wealthy families such as the Mars, Gallo, and Walton families contributed to abolition advocacy campaigns.

Yet the estate tax has had fickle public support, with ordinary people resenting being taxed as they imagine becoming millionaires. The abolition cause was boosted by right-wing message maestro Frank Luntz, who framed the tax as a “death tax.” Anti-tax advocates focused on convincing ordinary people that the taxman would show up at funerals, especially at family farms and small businesses.

Their mini-campaign received a huge boost when President George W. Bush included repeal in his 2001 tax cut proposal. But in order to fit within a ten-year budget framework, the tax was slowly phased out and then repealed in 2010 for one year only before having to be renegotiated. This famous “throw momma from the train” provision did benefit a few wealthy families. When shipbuilder and Yankees owner George Steinbrenner died in 2010, his estimated $1.1 billion fortune passed untaxed to his heirs.

In 2011, the estate tax returned and Congress increased the wealth exemption from $3.5 million to $5 million for an individual and from $7 million to $10 million for a couple, adjusted to inflation. The rate was dropped from 45 percent to 35 percent.

It would be fair to say the estate tax is a shadow of its former self since its more robust days prior to the 2001 Bush tax reform. Since 2001, the number of estates paying an estate tax has shrunk by more than 90 percent, falling from over 50,000 in 2001 to 5,219 in 2016. In 2001, two out of 100 estates were subject to the tax. By 2017, the tax was paid by only the wealthiest—two out of 1,000 estates paid.

The rate has also steadily been cut. Since 2001, the estate tax rate has fallen from 55 percent to 40 percent. In 2016, estate taxes of $18.3 billion were paid on total estate assets of $108 billion, an effective rate of 17 percent. At a time when the combined wealth of the Forbes 400 is more than $2.7 trillion, we can presume a high level of estate tax avoidance.

Donald Trump resurrected the call to abolish the estate tax, repeating tired talking points. “To protect millions of small businesses and the American farmer,” said Trump at an Indianapolis speech, “we are finally ending the crushing, the horrible, the unfair estate tax, or as it is often referred to, the death tax.” In fact, advocates of repeal have repeatedly tried in vain to find an actual family farm or business that had to be sold to pay estate taxes. (See “Estate Tax Fabrications.”)

In 2017, however, the opposition’s intensity was diminished. The lobbying efforts to abolish the tax did not approach the level of resources expended in 2001, raising the suspicion that many of the big money interests behind the repeal campaign had figured out ways to avoid the tax using trusts and hidden wealth mechanisms. The big advocacy dollars were focused on winning the corporate tax cut.

Since 2000, a growing number of wealthy U.S. nationals have deployed the offshore system and complex trusts to dodge estate levies and other taxes. For example, a trust mechanism called a Grantor Retained Annuity Trust (GRAT) has been deployed by hundreds of executives, according to Securities and Exchange Commission filings, including by Facebook founder Mark Zuckerberg, fashion designer Ralph Lauren, DISH Network Chairman Charles Ergen, and 84 current and former partners from Goldman Sachs, including CEO Lloyd Blankfein. JPMorgan Chase & Co. has so many clients that use GRATtrusts that they have a special unit of the bank devoted to processing GRAT paperwork. GRATs are complex trusts that include a “retained interest” for the wealthy grantor (like an annuity payout) and often enable them to transfer a substantial amount of wealth to heirs without taxes.

Casino magnate Sheldon Adelson created more than 30 GRATs to churn assets and annuities and avoid $2.8 billion in estate and gift taxes by shifting almost $8 billion to heirs. The creator of the trust, attorney Richard Covey, estimates it has cost the U.S. Treasury at least $100 billion in lost revenue.


Looking Forward

It’s time for a new approach. The premise of the estate tax, back when it raised serious money, was that the estate paid the tax. But when a progressive Congress revisits this issue, it makes more sense to apply the tax to their heirs, as just another form of income.

At the conclusion of Capital in the Twenty-First Century, the French economist Thomas Piketty calls for the establishment of a global wealth tax as a key intervention to move increasingly unequal societies away from our drift toward patrimonial capitalism.

Today, however, policy in most countries is moving in the opposite direction. Very few countries have robust estate or inheritance taxes and even fewer have annual wealth taxes. Even France, Piketty’s homeland, recently abolished its “solidarity tax” on wealth in 2017 as President Emmanuel Macron came into office. Prior to this action, France taxed wealth of over $1.3 million euros on an annual basis at progressive rates, ranging from 0.5 percent to 1.5 percent. France did retain a progressive inheritance tax, with steeply progressive rates depending on total wealth and the relationship to the decedent. France also has a luxury tax on gold bars, luxury boats, and cars.

Other countries with direct taxes on wealth include Switzerland, which taxes wealth at the canton level, as well as the Netherlands and Norway. Sweden abolished its wealth tax in 2007, concerned about capital flight.

Should the United States consider a wealth tax? As an interesting aside, in 1999 Donald Trump proposed a one-time 14.25 percent tax on wealth of over $10 million. Trump claimed the tax would raise $5.7 trillion that should be applied toward reducing the national debt.

The United States could explore a progressive wealth tax similar to the French “solidarity tax.” A graduated annual net worth tax on wealth of over $10 million could start at 1 percent and rise to 2 percent on wealth over $500 million. Such a tax, which could be promoted as an excise tax on hoarded wealth, could raise substantial revenue from those with the greatest capacity to pay.

On the other hand, it may be easier politically and constitutionally to make the case that inheritances should be simply taxed as income. A number of legal experts have suggested that the U.S. Constitution precludes a direct tax on wealth at the federal level. But there is no obstacle to taxing wealth when a transfer event occurs, such as an estate flowing to the next generation.


Taxing Wealth Transfers Going Forward

A progressive tax agenda must include strengthening wealth transfer taxes, whether as a more robust estate tax or a redesigned inheritance tax. Inherited advantage is disrupting social mobility and opportunity, creating dynamics of “dream hoarding”—blocking opportunity for non-wealthy people—among the super-rich, and distorting democratic institutions. Inheritances represent roughly 40 percent of all wealth, with bequests totaling about $500 billion per year.

A progressive wealth tax program could include strengthening the existing estate tax by broadening the base, instituting a more progressive rate, and reducing the wealth exemption.

For the last several congressional sessions, Senator Bernie Sanders has introduced his “Responsible Estate Tax Act” that would return the wealth exemption to $3.5 million and close some of the most egregious loopholes, such the GRAT trust. The Sanders proposal would also institute a graduated rate structure, with a 50 percent rate on estates between $10 million and $50 million ($20 million to $100 million per couple), rising to 55 percent for estates between $50 million and $500 million ($100 million and $1 billion per couple). A top rate of 65 percent would be levied for estates to the extent they exceed $500 million ($1 billion per couple). This progressive rate structure would raise an additional $243 billion to $288 billion over ten years.

As the estate tax approaches the 2025 transition point, there might be the leverage and political will to transition to an inheritance tax. New York University law professor Lily Batchelder has consistently made the case for converting the existing estate and gift tax into a direct tax on recipients of large inheritances.

This would include modifying the federal income tax to include income from inheritances and gifts above a certain threshold. Currently, if you find $5 million worth of cash in a bag on the street, you are required to declare it as taxable income on your tax return. But if your mother leaves you a $10 million inheritance, it is exempt from taxation.

Batchelder proposes that heirs of large inheritances pay income tax plus a surcharge on inheritances above a lifetime exemption. She proposes an annual exemption of $5,000 for gifts and $25,000 for inheritances, with a lifetime exemption of $2.1 million. Batchelder estimates that if a lifetime exemption is established at $2.1 million and the surcharge is 15 percent, such a tax would raise roughly $200 billion more over ten years than the 2017 estate tax. Increasing the rates or reducing the wealth exemption threshold would further boost revenue.

Emphasizing a tax on the heir—and calling it a “silver spoon tax” or “privilege tax”—sidesteps the communications challenges of the “death tax” attack. For example, instead of taxing Conrad Hilton, the virtuous industrialist, it would tax Paris Hilton, the idle heiress.

Inheritance taxes make good policy. Those receiving large inheritances have likely been beneficiaries of other intergenerational wealth transfers and social capital to give them more than an advantaged head start. As Batchelder writes, “Heirs of large inheritances also typically have a huge leg up in earning income if they choose to work—with access to the best education, influential family friends, interest-free or low-interest loans, and a safety net if they take risks that don’t pan out. This further strengthens the case for taxing inheritances at a higher rate.”

An inheritance tax may have the advantage of capturing wealth that has been hidden in trusts and in offshore systems. Economist Gabriel Zucman believes that the use of tax havens grew 25 percent between 2009 and 2015. He estimates that about 8 percent of the world’s individual financial wealth—almost $8 trillion—is hidden in these offshore centers. Wealthy U.S. citizens have an estimated $1.2 trillion stashed offshore, avoiding $200 billion a year in taxes. Some of this hidden wealth will be passed on to heirs through these hidden mechanisms, but to the extent it is passed on through inheritance, it could be taxed as income.

With wealth concentrated at its greatest level since the Gilded Age a century ago, there is no better time to strengthen U.S. wealth transfer taxes. 


Estate Tax Fabrications

South Dakota Representative Kristi Noem served as House Speaker Paul Ryan’s point person on the conference committee to reconcile the Tax Cuts and Jobs Act of 2017. For over a decade, Noem deployed a personal story of her father’s sudden death in 1994 and her family’s payment of the “death tax” as a heart-wrenching personal anecdote. “It wasn’t very long after he was killed that we got a bill in the mail from the IRS that said we owed them money because we had a tragedy,” Noem said in a 2015 speech on the House floor. “I didn’t understand how bureaucrats and politicians in Washington, D.C., could make a law that says when a tragedy hits a family they are somehow owed something from that family business.”

Noem became the case study of a tyrannical tax gone bad, soaking hard-working Midwestern farmers at a time of loss in a family’s life. She helped keep the focus on family farms as victims of estate taxes rather than on the super-wealthy who will owe the tax.

But tax experts asked why Noem’s family paid any federal estate tax at all. Since 1982, estate tax law has allowed an estate to pass to a spouse without tax. Noem’s mother, who is still alive to this day, should have used this spousal exemption. “It’s hard to believe the estate of a farmer who died in 1994 and was survived by his spouse was subject to tax,” said Robert Lord, a Phoenix tax attorney and expert in estate tax law. “It easily could have been deferred. That would have been a no-brainer.”

A team from the Institute for Policy Studies reviewed the public probate findings and exposed Noem’s misrepresentation. What triggered her family’s tax was a South Dakota estate tax provision, abolished in 1995, that had nothing to do with the federal estate tax. It was also revealed that between 1995 and 2016, her family-owned Racota Valley Ranch in Hazel, South Dakota, cashed in $3.7 million in government farm subsidies. In 2012 alone, they accepted $232,707 in subsidies. As Noem complained about government overreach and taxes, her family happily deposited hundreds of thousands in farm subsidies.

South Dakota media pursued Noem and questioned her veracity, weakening her position going into the conference committee. When it came time for Noem to forcefully make the case for estate tax repeal, she was cowed and quiet. A few weeks later, Noem announced her retirement from Congress to run for South Dakota governor. 

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