Estate Tax

"We can have democracy in this country, or we can have great wealth concentrated in the hands of a few, but we can't have both."

- Justice Louis Brandeis

What is the Federal Estate Tax and How Does It Work?

The estate tax is a tax on assets a person transfers to another upon death. These assets could include cash, investments, real or personal property. It was created in the late nineteenth century to help fund the Spanish-American War, but was later repealed. In 1916, it was reinstated to address revenue shortfalls caused by different factors. However, it was President Theodore Roosevelt who articulated a key moral argument for creating an estate tax:

The man of great wealth owes a particular obligation to the state, because he derives special advantages from the mere existence of government.

Here is how the estate tax works. Upon death, when property transfers from the deceased to a beneficiary, the tax is calculated. First, there is an exemption amount, which for 2014 is $5.34 million. That means that the first $5.34 million in assets are completely exempt from the tax. All assets above the exemption are then taxed at a certain rate (40 percent in 2014).

For example, assume John Smith dies in 2013 debt-free with $7 million in assets, which he leaves to his children. First, his children would receive $5.34 million, free and clear. The Smith estate would then take the taxable portion of the estate ($1.66 million) and multiply it by 40 percent (the estate tax rate for 2014), resulting in $664,000 in taxes owed. In other words, John’s children would inherit $6.336 million of his $7 million estate. Please note that because of the generous exemption amount, the Smith estate’s effective tax rate only 9.5 percent ($664,000/$7,000,000); this is the rate based on what the estate actually pays in taxes.

There are also certain deductions that further reduce the estate tax liability, including assets transferred outright to a surviving spouse, assets left to a qualified charity, mortgages and debt, and administration expenses of the estate (e.g. funeral expenses) and any losses incurred during the estate administration. Also, farms and family-owned businesses may qualify for a value reduction of an estate, thus reducing estate tax liability.

Why Does RESULTS Care About the Estate Tax?

RESULTS’ work focuses a great deal on funding programs that help lift and keep people out of poverty. That funding comes from taxes. When taxes are cut, there is less revenue available to fund important priorities like health care for all, early childhood development, and economic opportunity for all. This forces a choice of what is more important — concentrating more wealth into the hands of those at the very top or supporting policy that gives everyone a better chance at success?

The U.S. is a country built on shared wealth and sacrifice. Despite claims to the contrary, no one ever accumulates great wealth alone. As President Roosevelt indicated, society, and particularly government, contributes greatly to the creation and preservation of wealth through laws, law enforcement, economic policy, infrastructure, use of natural resources, support programs, and a host of other guaranteed rights and services. Without them, and the revenue to maintain them, it would be much harder, if not impossible, to accumulate and keep wealth. While there are vast inequities in wealth today, exacerbated by ideologies that deem all taxes as bad, the truth is that America only works when we all contribute our fair share.

The estate tax is not about punishing wealth (if that were the case, the estate tax rate would be 100 percent). Nor is it about demonizing people who are rich. The estate tax is about fairness. It is about saying that we are a society that believes in creating wealth, not concentrating it; we believe in opportunity, not privilege; we believe in fairness, not injustice. Those who have accumulated great wealth have a right to enjoy the fruits of their labor, something the estate tax does little to restrict. But they also have the responsibility to help ensure that the public structures and policies that facilitated their own success remain accessible to all members of society.

Who Pays the Estate Tax and Efforts at Repeal?

The estate tax, contrary to common belief, only applies to multi-million dollar estates. This means that very few estates are actually subject to the the estate tax.  In 2013, only 0.14 percent of estates (one in 700) would have owed any estate tax, and those that do would typically owe less than one-sixth of the estate.  Furthermore, many of the assets subject to the estate tax have never been taxed. For example, if at the time of death the deceased has real property, art, or stocks that have appreciated in value since they were purchased, these assets have never been taxed. A 2000 estate tax study cited by FactCheck.org showed that for all estates, 36 percent of capital gains had never been taxed; for estates worth more than $10 million, that number jumps to 56 percent.

Despite these facts, opponents of the estate tax have been very successful in convincing the American public that everyone will owe the government taxes at the time of death. Arguments that the estate tax disproportionately hurts small business and family farms have been particularly effective, despite no evidence to support it (in 2013, it is estimated that only 20 small farms and businesses nationwide owed any estate tax). As a result of these efforts, the estate tax has been reduced dramatically since 2001.

In 2001, the exemption amount for the estate tax was $1 million and the tax rate was 55 percent. That year, estate tax opponents, which were financed by some of America’s wealthiest families, convinced Congress to gradually reduce the tax. As a result, the exemption was gradually raised to $3.5 million and the rate lowered to 45 percent by 2009. Furthermore, in 2010 the tax was repealed altogether for one year, and was scheduled to return in 2011 to pre-2001 rules ($1 million exemption and 55 percent rate).  While repeal proponents had hoped there would be enough political pressure to enact a permanent repeal, the tax was reinstated in 2011, but in a much weaker form, with a $5 million exemption and a 35 percent rate.  The American Taxpayer Relief Act of 2012 (ATRA) permanently indexed the 2011 exemption amount to inflation and set the rate at 40 percent.  It is estimated that ATRA will result in a loss of $369 billion in revenue over the next 10 years relative to the pre-2001 rules.

There continue to be many members of Congress that support the complete elimination of the estate tax.  Repeal of the estate tax would be extremely costly. The Center on Budget and Policy Priorities estimated in 2009 that full repeal would cost the government $1.3 trillion over ten years. Considering the U.S currently has over $17 trillion in national debt, this fact alone should mute any attempts to cut the estate tax. Repeal or major cuts would also remove a key incentive for charitable contributions.

Responsible and Fair Estate Tax Proposals in Past Congresses

The Responsible Estate Tax Act (RETA), S.3533, introduced in the 111th Congress, would have brought fairness back to the federal estate tax. RETA was introduced by Sens. Bernie Sanders (I-VT), Tom Harkin (D-IA), and Sheldon Whitehouse (D-RI). It would have reinstated the tax but exempted all estates worth less than $3.5 million per individual or $7.0 million per couple (the same as 2009 levels). With these exemption amounts, 99.7 percent of all estates would be exempt from the estate tax. Under RETA, estates worth between $3.5 million and $10 million would be taxed at a 45 percent rate; estates between $10 million and $50 million at a 50 percent rate; estates above $50 million at a 55 percent rate. Studies show that estates subject even to a 55 percent statutory tax rate actually pay less than 20 percent (the effective rate). Also, estates worth more than $500 million per individual ($1 billion per couple) would have a 10 percent surcharge added. Finally, although very few farms and small businesses are subject to the estate tax, the bill contained provisions to allow small family farms and businesses to reduce any potential estate tax liability.

The Sensible Estate Tax Act of 2009, H.R.2023, was introduced by Rep. Jim McDermott (D-WA-7) in the 111th Congress. This bill would have partially rolled back some of the generous estate tax cuts since 2001. The bill would have reset the exemption amount to $2 million and index it to inflation. Also, like RETA, it would have created a graduated rate system: assets over $2 million taxed at a 45 percent rate; assets over $5 million taxed at 50 percent; assets over $10 million taxed at 55 percent. It would have also unified the estate and gift tax provisions of the tax code, allowed a surviving spouse to claim a deceased spouse’s unused exemption amount as part of their own exemption, called portability, and allowed estates to use state estate taxes as a tax credit against their federal estate tax.

Additional Resources: