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Eliminating the Death Tax

Tree Farmer Magazine: November/December 2000 - Volume 19, No. 6

This summer Congress finally got serious about estate and gift tax relief. But, by now the President has vetoed HR 8, "The Death Tax Elimination Act of 2000." The term "death tax" is used to refer to the estate, gift, and generation skipping taxes. What did we lose? The bill is worth analyzing because it reflects the direction Congress is likely to take this fall in any compromise bill acceptable to the White House.

Veto By White House

What did the White House object to? Their primary objection was a reduction in tax revenue by an estimated $28.3 billion for the 2001 to 2005 fiscal years. They also objected to any reduction in the progressivity of the overall Federal tax system, and provision of a benefit for only about 3,000 taxpayers who can't vote. Progressivity refers to the principle that those with higher incomes and wealth should pay proportionately more of the total tax collected. Since the estate and gift tax impacts only estates over $675,000 there's no doubt that relief would go primarily to those with some wealth. But, is the hassle of the death tax system worth the trouble it causes to many more than the 3,000 who pay the tax each year? How much do voting taxpayers spend each year to arrange their affairs to minimize the portion of their estates going to the IRS?

As Tree Farmers we have a vital interest in death tax relief. Like farmers, many of us have wealth tied-up in real estate -- land and timber. Ownership of assets, however, doesn''t necessarily translate into the ability to pay either property taxes or death taxes.

The Current System

Let's review the critical elements of the current death tax system. Recall that the so-called unified federal death tax law taxes gifts and transfers at death at the same rate. Gifts are taxable to the extent they exceed $10,000 per year to any number of recipients. At death taxable gifts are added to amounts transferred by will to determine the gross estate. After the gross estate is reduced by authorized deductions to determine the taxable estate, a unified tax credit tax credit offsets the tax on a given dollar amount of taxable estate.

What Did We Loose?

So what would The Death Tax Elimination Act of 2000 have done? Most importantly is would have phased out the estate and gift taxes over a 10-year period. It's immediate impact for anyone dying after December 31,2000 would have been to reduce the top tax rate from 53 percent plus a 5-percent surtax to a 50-percent maximum. Then, all the rates would have then been reduced annually until the tax was eliminated for decedents dying after December 31, 2009. On a technical note, it would have replaced the unified credit with a specified value of assets exempt from taxation. Because the unified tax rate would still apply, the rate reductions also would have applied to gifts and generation-skipping transfers. The later are transfers to your grandchildren or any later generation.

Limitation on Step-Up In Basis

There's nothing to complain about so far, but the change in the stepped-up basis rules could have generated some heartburn. Recall that the basis of inherited assets is the fair market value of the asset on the date of death or six months later. This means that any increase in value while an asset was owned by the deceased is not subject to income tax. The applicable income tax rate would normally be the capital gains rate of 10 or 20 percent (possibly 8 or 18). Under The Death Tax Elimination Act of 2000 an executor could have applied the stepped-up basis rule to $3.0 million worth of assets going to a spouse, and $1.3 million going to anyone. The executor could have chosen the assets to receive this treatment.

The issue is whether the elimination of the stepped-up basis is worth the savings in estate taxes. There isn't adequate data to answer this question in general. But, since the current stepped-up basis applies whether or not the estate is taxable, it benefits many more taxpayers than those who pay estate taxes. The $3 and $1.3 amounts would cover a majority of estates, providing both the estate tax reduction and income tax savings. For taxable estates with assets above the caps the beneficiaries would pay the 20 percent capital gains rate and the estate would pay a maximum 50-percent rate.

The following article has been reproduced here from the "Tree Farmer" magazine with the permission of the American Forest Foundation, 1111 19th Street, N.W., Suite 780, Washington, D.C. 20036. (Telephone 202.463.2462)