Like Jonathan Orszag, I don't really understand why we (used to) tax estates rather than taxing inheritances. If Sheldon Adelson wants to give $50 to each American when he dies, there's no particular reason for the taxman to take a bite out of that. Conversely, if 100 different people all die in 2008 and each leave me $900,000 I really ought to may some taxes on my $90 million windfall. In practice, I imagine the consequences of switching from one situation to another wouldn't be large as these kind of extreme scenarios are obviously unlikely, but still it seems like we ought to do this properly.
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Tax Inheritance
25 Jan 2008 05:28 pm
Comments (27)
As I understand it, an inheritance tax is somewhat more difficult to administer for valuation reasons. With an estate tax, the executor just needs to place a value on the decedent's estate, whereas with an inheritance tax, he/she would need to determine the value of each beneficiary's interest, including future interests, in order to apply the inheritance tax.
So if a trust is set up to provide income for life to A, with the trust property then passing to A's heirs upon A's death, we'd need to figure out the value of A's interest in the trust, as well as A's heirs, in order to tax them appropriately. With the current setup, however, the whole trust would just be taxed to the estate.
This alone can't justify the estate tax obviously, but there it is.
In addition, there might be a reason to tax the estate of those $50 gifts you mention, if you take the view that the estate tax functions as a delayed payment for the state's protection of property during one's life. Also, the estate tax would mop up any income tax evasion that may have occurred, and gone undetected, during life.
Well, in the case of a person with a large estate leaving small inheritences to many people, the government receives far less revenue. I'm not sure whether the "hundred people leaving small inheritences to one person" scenario would crop up enough to make up for the lost revenue.
Raising revenue is the essential purpose of the estate tax, so anything likely to reduce how much revenue it raises has a definite cost. Naturally, there are other ways of increasing its take, from raising rates to lowering minimum estate or inheritance values, but it's not obvious to me that these are better than continuing to tax estates rather than inheritences or doing without the lost revenue.
Why not just treat your "income from an inheritance" as just regular income and tax it as such? This would make it much harder for the opposition to argue why "inherited income" shouldn't be taxed while all sorts of other income should be. You can always put in some limited exemption if you really need to.
I'll bet that the original reason for the distinction was that the taxes on "estates/inheritance" where always much, much higher than regular income taxes, instead of being zero as they are now.
No one back then could have possibly imagined that one political party would be so totally suicidal as to reduce "estate taxes" BELOW regular income taxes.
Or that the other political party would be so totally incompetent to let them get away with it, instead of being annihilated at the next election.
We just live in very peculiar political times.
The simple answer is taxing inheritance opens it up for all sorts of schemes to lower the tax such as trusts and other ways of doling out the money to avoid the thresholds.
There is a second reason though--in that by taxing the estate you are essentially taxing value that one person gathered and much of it hasn't been taxed previously. If you divide it up, that money is never taxed as a capital gains or income.
The problem (from the govt's perspective) with taxing income from an inheritance as regular income is that the government would lose revenue, since the beneficiary of a trust may not receive income for years, or even decades after the person dies. So instead of getting a big pile of money today, the government gets small payments stretching way out into the future.
the latter scenario isn't just unlikely.
Isn't another problem that the person receiving the inheritance might not have liquid assets to pay the tax?
Under your example. 100 worth 90 million dollars each could each leave 900,000 to the 100 descendants. Each descendant would then collect 90 million dollars, as if the original estates had passed to them directly. Except, they wouldn't pay taxes.
That's funny, I just completed my will. And I decided to leave Matt exactly $900,000 dollars.
Of course, my savings are in Zimbabwe dollars, which just recently released the new $10,000,000 note:
http://www.gadling.com/2008/01/22/zimbabwe-releases-10-million-bill/
This note is worth about US$4.
I totally agree with RKU.
There's 2 simple rules here:
1. When you GET money that wasn't previously yours - no matter how - paycheck, dividend, gameshow win, suitcase of $20's found in a ditch, or a gift from a dead person - you pay tax on it.
2. You and your spouse are considered 1 person for tax purposes, so if he/she leaves you money, it's not considered new money to you.
These 2 tenets are deeply ingrained in our tax code. Why should inheritance be special? It's just another version of money finding its way into your pocket that wasn't there the day before. I find anti-'death tax' arguments flimsy as crepe paper.
Raising revenue is the essential purpose of the estate tax
No that is a side benefit. The purpose of the estate tax is to reduce dynastic wealth and to provide a brake on the laws of compound interest.
Why do you think the government deserves a piece of everyones' pie? This is the most senseless thing you've ever said....among many. Again, you've passed the Liberal Fascism test....Maybe you're beginning to understand - though I doubt it.
I would also add that you could establish foundations as well as trust funds that theoretically work for some charitable causes, but in reality exist to give payment and perks to members of the family.
My understanding of the estate tax is that it is intended to be a tax on the person who created the estate, but as a special privilege to the very wealthy they don't have to pay until they are dead.
As I understand it, an inheritance tax is somewhat more difficult to administer for valuation reasons.
But all these inheritors file annual income statements with the irs. Just make them declare it.
RS
I don't understand where there would be any valuation problem at all. Estates that are taxable now by Feds or the states get valued for the tax as of the date of death.
If it switches to inheritance, it will also have to be valued, just probably a different date.
It already happens when inherited items aren't reported at death. When the heir come to sell that inherited item that wasn't reported (unless, er, they sell it for cash) you either go and get an appraisal of its value at the time it was transferred to you, and argue that you owe cap gains only on the difference between the value then and the value now, or you pay cap gains on 100% of the current value.
You don't even run into this with things like real estate or financial items, as er, the government has paperwork on that stuff.
For personal property of high value, as a matter of fact, lots of people seem to have advisors telling them to get "stepped up basis" appraisals when inheriting recently. I am not an accountant and don't fully understand why it's happening, but I definitely see it happening. Maybe they want to pay tax now because the rates are set to be higher later?
P.S. Just to be clear, I am not talking about only the ultra rich here. Many don't seem to be aware that there are still quite a few states that have estate tax at lower cut off level than the Federal estate tax. Wisconsin, for example, taxes estates over $600,000 last year. If your parents have a nice house and a number of valuable heirlooms that are being left to you, after they both die, you and your siblings might need an appraisal and have to pay estate tax in a state like Wisconsin. The tax itself, it's often not that high, but it's a lot of legal rigamarole complying with it. Parents often do children a favor and transfer the valuables before death, pay gift tax instead.
I don't understand where there would be any valuation problem at all.
It's not a huge problem, but here's what I was thinking of: Say a person dies with a $1 million trust in their estate, and nothing else, and say the tax rate is 50%. With an estate tax, when that person dies, the estate would owe $500K in taxes regardless of how many present and future trust beneficiaries there are. With an inheritance tax, however, the individual values of all the present and future interests of the trust would have to be determined, so that we could determine the liability of each inheritor. So beneficiary A might owe $50K, beneficiary B might owe $75K, and so forth, depending upon how the trust is structured, what the actuarial tables say, and what tax rate would apply to different classes of beneficiaries (e.g. siblings, children, strangers). So it's a bit more work for the executor.
Also, in addition to this administrative hassle, if we decide not to tax trust beneficiaries until they actually start receiving income, as some here have suggested, then the government loses revenue by reason of the delay in payment. Of course, this loss probably wouldn't be all that substantial in terms of total tax receipts, but I don't think this is a good time to be lowering taxes on large estates, and an inheritance tax would probably result in slightly less revenue if it's going to be fair.
RS
Well, those are interesting points that can actually take you in many directions...some random thoughts....
A lot of people expounding on it have no idea how complicated the value of personal possessions can get.
Inheritance tax where the inherited property easily divisible would actually be more fair to the heirs if you would be treating each of them with something progressive according to their own wealth. And it sounds so nice and easy.
But then there's the problem is that things are not always easily divisible. And with some things, when you divide them, you can increase or decrease their value immediately! A farm sub-divided among siblings ends up with totally uneven values quite different from the farm as a whole. I'm absolutely no good with financial stuff but I have enough idea to know that dividing up a clump of stock with voting power in a corporation would change things.
There is an example in my own field that instructors like to use: a set of 4 fine American Federal period antique chairs is worth a hell of a lot more than the individual values of those chairs x 4. I won't get into it because explaining it gets too complicated, but you wouldn't believe what the IRS valuation rules makes appraisers do in a case like that for gift tax if it's 4 kids each inheriting one chair.
Yes, definitely, it is therefore much simpler to tax the estate as a whole at death before it is divided. But then, everyone has to file their taxes every year and it wouldn't be that big of a deal to have them adding what they inherited that year along with the way the interest on their savings account is added. The latter system is actually quite bureaucratic, if you think of it, the banks all required to send out the forms to both each and every account holders and the government. Payroll tax is an incredibly complicated system, too. People will have complex income from time to time, that's just part of having an income tax, and is why the flat taxers can always get a fan base.
My own two cents on what I know and I am only feel free saying it because I am not writing under my own name: taxing people on appraised antiques and fine art is not at all a science, we appraisers have a wide fudging leeway. Ergo: it's not fair, not fair at all, way way more unfair than those tax assessments on real estate, and one can play all kinds of games. The fair scientific way would be to tax them on transactions, when they sell it, on 100% of what they sell it for, forget estimates of what it worth at their father's death or when it was gifted to them. This would take a lot of business away from people like me, but it would be a hell of lot more sensible that what they try to do now. Likewise, I don't see the theoretical sense in taxing people on a valuable piece of non-income real estate if they decide to keep it and use it as their family did before them. Tax them if they sell it is what seems sensible to me.
BTW, the latter is not what I would recommend for some parts of Latin America. :-) But we don't have the same problems with landowning here. In actuality, when we had them in the past, it turned out pretty good, many of the big robber baron lands ended up as public preserves like the Rockefeller's Adirondacks.
Financial instruments are a whole different ball of wax, but taxing non-income real property and personal property outside of transactions is always fraught with problems.
p.s. to last: Another example of how complicated this can get is what's called the blockage discount, which the I.R.S. does allow for the value of many kinds of property for taxes. That's giving it the value as if you dumped everything on the market at once, it would lower its value. Since with estate tax you are valuing for a single day, it applies. Now after hearing about that, most people would picture a Paris Hilton inheriting a big block of stock and think-hey, they're giving those wealthy pigs a break, sock her the full individual current value. They don't see other examples like the artists' families with storerooms full of paintings by their dead father who never got that much for his work and whose reputation they would ruin by dumping it all on the market at once and who don't have the cash to pay for the appraisals, taxes and storage fees without a blockage discount. Things like estate tax on personal and non-income real property are why there are tons of I.R.S. regulations and rulings and tax cases that revise the rules. It's very labor intensive to get that money no matter how it's done. Like I said earlier, income tax also costs a lot of labor to collect and can be just as complicated, so I am not arguing one way or the other, just pointing out it's not the easy money for the government that some people think it is, especially if you want to be fair.
speaking of tax policy, can I just make a side note about the benefits of a 90% tax rate?
With a 90% tax rate, you discourage 'lottery ticket' thinking on the part of CEO's and others who have lots of way to 'game the system' to get potentially crazy pay outs from bonus packages, etc.
Just as a thought experiment - imagine how a Dutch tulip bulb pricing bubble would happen with a reasonably calibrated 90% tax rate. (The correct answer: it wouldn't happen, because at some point you'd simply max out the pyramid scheme and short circuit the whole thing.)
We used to call it the "inheritance tax". We also used to talk of "Social Programs" (instead of 'entitlements').
But that was a different time.
the reason it's an estate tax rather than an inheritance tax is historical path dependence. taxes originated with things that were easy for a low efficacy state to observe and extract like tariffs (just keep a taxman stationed at the port) and property taxes (try hiding land from the taxman). only after the state achieves tremendous efficacy can it use much more intrusive taxes like income tax and VAT, both of which require an almost omniscient view of the economy. in the West, states basically achieved that kind of efficacy only in the late 19th century.
inheritance is basically income (and therefore hard for a low efficacy state to observe) whereas estates are basically property (and therefore easy for a low efficacy state to observe). thus we have estate taxes because we started taxing estates/inheritances in an age of property taxes but not income taxes and we've never changed it.
Gifts and bequests are not income to the recipient under the Internal Revenue Code. Maybe there is a historical resistance to changing this.
When someone dies leaving a property with unrealized capital gains, those gains escape taxes forever. The recipient takes the shares of stock, real estate, etc., with a basis calculated on the date of death. This may be the single biggest loophole in the tax code. I suspect that repealing it would raise some resistance.
The estate tax is not about raising money for the government, it's about placing curbs on the power of accumulated wealth, by pushing rich people to behave in certain ways (gifts to charity, relinquishing control to a trust) and not in others (huge bequests to the kiddos). Moving to an inheritance tax would remove most of these incentives, I think.
"Conversely, if 100 different people all die in 2008 and each leave me $900,000 I really ought to may some taxes on my $90 million windfall."
Thank God I saw this. Matt, you can only count on 99 such deaths now.
"No one back then could have possibly imagined that one political party would be so totally suicidal as to reduce "estate taxes" BELOW regular income taxes.
Or that the other political party would be so totally incompetent to let them get away with it, instead of being annihilated at the next election."
The reason isn't incompetence, but rather having the same wealthy campaign contributors as the GOP.
Since the intelligent points have been made let me just add that taxing recipients instead of estates might as well be called The Tax Attorney and Accountant Employment Act of 2009.
Instead of paying one set of lawyers and accountants to prepare for a range of contingencies you set up the potential of dueling lawyers and litigation forever. One man, one plan, one check to the IRS. KISS or as simple as it can be given the Tax Code.
Comments closed February 08, 2008.
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Heads in the Sand
My understanding here is that the real problem is addressing trust funds. Maybe that had something to do with the previous practice, but from what I understand, it wasn't very effective either.
Suppose the estate is basically set up to pay me, as the inheritor, money over a period of time. It may even be administered to buy me things so that the money never actually show up in my hands. So things can be tricky, I would guess.
Of course, I am very receptive to the idea of taxing large inheritances heavily. One of the problems with your idea, is that, of course, the taxman would like to take a bite out of Sheldon Adelson when he dies regardless of what he does with the money. But, yes, it seems clear that the socially desirable and correct thing to do would be to tax inheritances. Good luck getting a law through Congress that does this, much less closes all the loopholes correctly, however.
Posted by mpowell | January 25, 2008 5:54 PM