Estate Tax Repeal - Good or Bad News for Planned Giving? - Part II

Estate Tax Repeal - Good or Bad News for Planned Giving? - Part II

Article posted in Legislative on 31 August 2000| comments
audience: National Publication | last updated: 18 May 2011
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Summary

Although H.R. 8, the Death Tax Elimination Act of 2000 was vetoed last week by President Clinton, it may still be enacted into law. This article continues the discussion from Part I, which outlined in detail the various changes that would occur over the next decade if H.R. 8 is passed. Part II explores the various arguments both for and against the repeal of transfer taxes and are presented with special attention given to the effects such sweeping legislation would have on the charitable community in general and planned giving in particular.

by: Emanuel J. Kallina, II, Esquire & Jonathan D. Ackerman, Esquire

Click here for Part I

Executive Summary

This article continues the discussion from Part I, which outlined in detail the various changes that would be enacted over the next decade if H.R. 8, the Death Tax Elimination Act of 2000 is ultimately enacted into law. Among other things, the bill would replace Transfer Taxes with a carryover basis structure. Part II reviews various arguments both for and against the repeal of Transfer Taxes, paying special attention to the effects such sweeping legislation would have on the charitable community in general and planned giving in particular.

Introduction

As noted in Part I of this two-part series, the House of Representatives passed H.R. 8, the Death Tax Elimination Act of 2000, on June 9, 2000, by a 279-136 margin. 1 The Senate then passed H.R. 8 on July 14 in a 59-39 vote.2 President Clinton vetoed H.R. 8 on August 31. If ultimately enacted into law, H.R. 8 would phase in a repeal of the estate, gift and generation-skipping transfer taxes ("Transfer Taxes"). These taxes would be replaced with a carryover basis structure. Similar legislation to repeal the Transfer Tax system was vetoed by President Clinton in 1999. However, the public's interest in such legislation appears to have increased since 1999 and if the Republicans win the Presidency and retain control of both houses of Congress, similar legislation could have a very good chance of getting passed into law in the future.3

Because of concerns over how charities should position themselves with respect to this type of legislation, we will report some of the main arguments that we have heard both for and against the Death Tax Elimination Act of 2000, without expressing value judgments about them. With this in mind, you will note that in some cases the arguments are internally inconsistent. Further, as is the case with most political issues, the same allegedly factual information used to support one side of the issue sometimes appear to be used to support completely contradictory conclusions on the other side.

Pro - Arguments in Favor of H.R. 8, the Death Tax Elimination Act of 2000.

Numerous arguments have been made in favor of H.R. 8, which, as noted above, would phase in a repeal of the current estate, gift and generation-skipping transfer tax system over 10 years and then replace that system with a carryover basis structure. Many proponents of H.R. 8 state that the Transfer Tax system is unfair and immoral. More specifically, some of the arguments we have seen in favor of repealing Transfer Taxes are as follows:

  • The Transfer Tax system should be repealed to save all the family businesses and farms that have to be liquidated to pay these taxes. The estate tax makes it difficult, if not impossible, to pass family businesses and farms down to the next generation. These entities are forced to spend money on avoiding or paying the tax rather than on purchasing or building new equipment needed for operations or hiring additional workers. For example, the owners must spend money on expensive life insurance policies to pay the tax if they want their businesses to survive to the next generation. Many people lose their jobs when family businesses and farms are forced to close down to pay the tax, and the resulting social costs of restructuring the economic fabric of our country is too high.

  • It is inappropriate for the government to try to redistribute wealth. The transfer tax is akin to a form of communism. It treats households that save money worse than households that spend lavishly. The tax penalizes those who simply wish to make life better for their children and who fail to do extensive estate planning. There is no legitimate reason to single out the small percentage of people who wind up paying estate taxes just because they have worked hard to provide for their loved ones. Freedom and private ownership of property are important principles to Americans and the government does not have the right to take property from people at death. There should be no limits on a person's ability to pass along his or her wealth to his or her heirs.

  • The Transfer Tax system does not even cause a redistribution of wealth, which is one of its stated purposes. A tax that produces such a small portion of federal revenues could not possibly have much impact on wealth equality. The tax has far outreached its goal of preventing the concentration of wealth in and the control of industry by a small number of families and is now harming small businesses. Transfer Taxes may even cause greater inequality by encouraging people to spend more during their lives, thus magnifying consumption inequality and gaps in the standard of living.

  • Assets subject to the estate tax have already been taxed by the income tax system so it is improper for the government to tax them again at a person's death.

  • The Transfer Tax system is not as progressive as its supporters argue because the tax is easily avoided with good estate planning.

  • The Transfer Tax system is bad for the economy because it reduces savings, wages and, as noted above, labor and capital investment. In addition, the current provisions giving a stepped up basis to property passed at death are inefficient in terms of the flow of capital. These provisions encourage people to hold onto assets that may be generating low profits in order to avoid the capital gains tax. The money individuals and businesses spend on complying with and avoiding the Transfer Taxes could be better spent on other things, such as providing health insurance to more people. If the Transfer Tax system were repealed, money that would otherwise go to the government would instead be put back into the economy.

  • Death is not a good time to impose a tax. The Transfer Tax system is a form of grave robbery and it causes further agony to those mourning the loss of loved ones.

  • The costs of the Transfer Tax system are equal to or higher than the revenue it generates. Revenues generated by the estate tax last year were less than 2% of total federal revenues so elimination of the tax would make little difference to the government. Compliance with and avoidance of the overly complicated tax require lots of attorney time and complex planning strategies. The costs of the tax do not justify its possible benefits.

  • Despite statistics showing that only a small percentage of people are actually subject to the estate tax, the impact of the tax extends not only to those with taxable estates but also to all who inherit assets from such estates. As mentioned above, the tax also impacts those people who lose their jobs when businesses or farms must be shut down to pay the tax. Therefore, the number of people impacted by the tax is much higher than some estimates would lead one to believe.

  • The Transfer Tax system shifts money to the government which often does not spend the money wisely.

  • Those arguing against repeal of the Transfer Tax system on the basis that repeal would be foolish and akin to the Reagan-era tax cuts that caused massive deficits in the federal budget are exaggerating. The repeal of the Transfer Tax system would have a much smaller impact on revenues than the tax cuts made in the 1980s. Moreover, this is a good time to repeal the tax because the economy can afford it now.

Some people who are in favor of repealing the estate tax (or who are at least trying to see the bright side of repeal if it does happen) have noted some neutral or even potentially favorable effects on charitable giving:

  • The estate tax has little or no impact on charitable giving as a whole. Most people who give do so because they want to support specific causes and programs, not merely to avoid a tax. These people would continue to make charitable gifts regardless of the Transfer Tax incentives or lack thereof. In any event, people would still make charitable gifts to take advantage of the income tax charitable deduction.

  • If the Transfer Tax system were repealed, many people would review their estate plans and this would offer charities a chance to provide these people with information about charitable giving.

  • Repeal of the estate tax and the related charitable deduction could simply cause people to give more away during life rather than waiting until death so as to avoid the carryover basis on assets passing at death.

  • The new carryover basis structure would increase the incentives for charitable remainder trusts to be created at death or by the persons who have inherited property as a method of avoiding capital gains when inherited assets are subsequently sold.

  • Repeal of the Transfer Tax would increase overall wealth which would in turn increase charitable giving.

Con - Arguments Against Replacing the Estate Tax with Carryover Basis

As you might expect, there are also numerous arguments on the other side of this issue. Some of the assertions being made in support of the current Transfer Tax system are as follows:

  • Elimination of the Transfer Tax system would result in a massive windfall for the wealthiest Americans. Estimates indicate that only 7/10ths of 1% to 2% of those who die pay estate taxes. Moreover, the bulk of the estate taxes are paid by the wealthiest of that already small group of people. The statistics indicate that the people paying the estate tax still have very high incomes at the time of their deaths.

  • Although repeal of the current estate tax would relieve the tax burden on the wealthiest people, the burden itself does not completely disappear. The proposed carryover basis structure would simply shift that burden to average people. Tax cuts should be directed at those who need the tax cuts the most. The estimates on the decrease in government revenues anticipated from the repeal of the Transfer Tax system are "net" numbers in that they take into account not only the negative impact from the repeal of the estate tax but also the positive impact of the imposition of the carryover basis structure. Although we do not know the answers, we should be asking for more detail on the numbers underlying the estimated revenue impacts. Despite the estimated decrease in government revenues, it is possible that the government could even wind up taking in more money under the new structure.

  • Redistribution of wealth and of the control of industries is an acceptable and important goal of a democratic government and the current Transfer Tax system serves this goal. The Transfer Tax system increases the equality of income and wealth in the country which in turn increases the equality of opportunities. Repeal of the tax would further widen the gap between the poor and the rich, which might lead to societal instability. The current tax structure forces people to redistribute their wealth by giving it to the government or, if they do it intelligently, by giving it to charity. Most other countries also have some sort of system for taxing wealth transfers.

  • Even if the estate tax is viewed as a tax on the recipients of inherited property rather than on the deceased, those recipients are also generally at the high end of the wealth spectrum.

  • Most of the benefits accruing from a repeal of the Transfer Tax system would not go to family businesses and farms. Only a small fraction of family businesses and farms pay any estate taxes and those that do pay estate taxes are generally liquid and owned by some of the wealthiest people in America.

  • Repeal of the whole Transfer Tax system is broader relief than is necessary if the goal is to save family businesses and farms. Additional tax breaks targeted to these entities would be a more appropriate form of relief. Current law already includes generous tax relief measures for family businesses and farms. In addition to special deduction, deferral and valuation provisions for these assets, annual exclusions are available for lifetime gifts generally. There are also numerous estate planning methods available to reduce or eliminate the tax under current law. Because only a tiny portion of the government's revenues come from estate taxes on family businesses and farms, it would be acceptable to provide more relief to them under the current system.

  • Repeal of the Transfer Tax system would have an extremely high cost for the federal government. Contrary to what the proponents of repeal would lead one to believe, the Transfer Tax system raises billions in revenue for the federal government. The Joint Committee on Taxation has estimated the cost of the phased-in reduction in Transfer Tax rates at approximately $105 billion over the first 10 years. 4 Once repeal kicks in, estimates are that the lost revenues would amount to $50 billion per year. 5 The high costs of the repeal will be particularly apparent as more baby boomers retire, which will put more stress on social security, Medicare and Medicaid. This stress may result in increased government spending which will in turn cause increased deficits. More government money will be directed towards interest payments on debt rather than desirable government programs. Just because the economy is doing well now doesn't mean that the government has to squander the surplus by eliminating altogether a tax designed to create equity and fairness in society.

  • The Transfer Tax system is progressive because it is levied on the wealthiest individuals. In contrast, the proposed carryover basis structure would effectively constitute a flat tax system on estates. The Transfer Tax system contributes to the progressiveness of the income tax system and helps offset the regressiveness of the sales and consumption type taxes. The need for the additional progressivity provided by the Transfer Tax system is greater now because of the increases in wealth and pre-tax income in recent years. Also, because of the preferential tax rates for capital gains in current law, it would be difficult to make the income tax system sufficiently progressive if the Transfer Tax system were repealed.

  • The Transfer Tax system is not imposing a second tax on income that has already been subject to the income tax. Most of the estate tax is paid on the appreciation in assets which has not previously been taxed. The Transfer Tax system is necessary to close what would otherwise be a loophole in the income tax system.

  • The imposition of a carryover basis structure in exchange for the repeal of the Transfer Tax system is the trading of one evil for another, potentially worse, evil. The new carryover basis structure will serve as a sort of full employment act for accountants, who will likely find a lot of work in sorting out all the complex basis, holding period and capital gains tax rules. The accounting nightmares may be staggering. It will be difficult if not impossible for executors to choose which assets should receive a stepped up basis. Families that would not otherwise need to seek help from tax professionals would be required to consult with such professionals for help in allocating basis. Estate planners will simply shift their focus over to avoiding capital gains. In addition, if the country runs into economic problems down the road, it is very possible that the capital gains tax rates would be increased to raise more money.

  • Even more disturbing is the past history of similar carryover basis legislation. Such a structure was enacted as part of the Tax Reform Act of 1976 and then repealed as unworkable. This law even had provisions (i) specifying that if the necessary facts were unknown to the recipients of the property, the approximate fair market value of the asset on the date of the decedent's acquisition could be used to govern carryover basis and (ii) providing for a January 1, 1977, "fresh start" for property owned prior to that date. However, even with these safeguards, the legislators subsequently found it necessary in the Revenue Act of 1978 to postpone the effective date of the carryover basis provisions until December 31, 1979. There was substantial criticism of the carryover basis provisions as "extremely complex and administratively unworkable." 6 Testimony indicated that the provisions caused a large increase in the time necessary to administer an estate and in the costs of such administration. 7 Ultimately, the Crude Oil and Windfall Profit Tax Bill of 1979 retroactively repealed these provisions altogether. The carryover basis structure enacted in 1976 had fatal flaws. In analyzing the current carryover basis proposals, it is necessary to ask whether those fatal flaws have been resolved.

  • The estate tax is not a harsh burden on grieving families because the tax can be deferred in many cases by provisions in the current system and it may be prepaid by paying premiums on life insurance policies used to cover the tax.

  • It is likely that many polls that have indicated increased public support for the repeal of the estate tax would have different results if the question were asked in a different way. If individuals were asked to rank all taxes in terms of the order in which the individuals would like to see the taxes repealed, it is probable that the estate tax would not be at the top of the list. The public does not fully understand the tradeoffs necessary in terms of the other taxes that cannot be reduced or the other programs that cannot be funded if estate tax repeal is undertaken.

  • The evidence does not support the argument that the Transfer Tax system is a disincentive for savings, labor and capital investments. A tax imposed during life, such as the income or capital gains tax, is more of a disincentive on savings, labor and capital investments than a tax imposed at death.

  • The Transfer Tax system is a relatively inexpensive and convenient way to raise revenue.

  • The local probate process necessary to transfer many assets at death tends to generate information about a person's wealth that is not otherwise readily available.

  • In a report issued by the Center on Budget and Policy Priorities ("CBPP") on August 30, 2000, CBPP states that the repeal of the federal estate tax would result in the automatic repeal of state estate tax revenue for most states. These states will either maintain an estate tax, impose an inheritance tax, create a new tax, or increase state taxes elsewhere in order to make up the billions of dollars of lost revenue.

  • The proposal to repeal the Transfer Tax system is simply political posturing. This type of legislation is a fund-raising tactic for politicians attempting to raise money from wealthy individuals. As noted above, the Transfer Tax repeal legislation would benefit the super wealthy. As such, it is in accord with the priorities demonstrated by the Republicans in the House of Representatives who have been largely ignoring corporate tax abuses. It is another attempt by the Republicans to re-orient all tax laws to favor the rich. However, this issue is not entirely partisan. Democrats from wealthy areas have also joined the battle for repeal of the Transfer Taxes as an appeal to their own wealthy constituents. Both parties gain political mileage from this issue and know that they could use a subsequent compromise to their advantage: Depending on the exact form of the compromise, the supporters of repeal may still be able to claim that they have saved the family farms and businesses and the supporters of maintaining the current structure could still say that they have prevented a huge tax break for the wealthy.

As was the case on the other side of the issue, there are a number of arguments for retention of the current Transfer Tax structure based on the benefits to charities:

  • The current Transfer Tax system encourages charitable bequests and other types of charitable giving. The high estate tax rates combined with the estate tax charitable deduction are significant incentives for charitable contributions, especially for large gifts by the wealthiest people. A few years ago, the Council on Foundations and Independent Sector commissioned a report on how various proposals to reform the tax code would impact charitable giving. The resulting report prepared in 1996 by the Washington National Tax Service of Price Waterhouse LLP and the Washington law firm of Caplin & Drysdale estimated that the elimination of the estate tax charitable deduction would radically impact charitable giving to the tune of $3 billion per year. Moreover, it is important to keep in mind that charitable giving has increased greatly in recent years and much of this planning has been done by people who are still living. Tens of trillions of dollars are expected to pass down to the next generation as the baby boomers die. Any predictions about the potential impact of changes in the Transfer Tax system on future charitable bequests and other forms of planned giving are woefully inadequate to the extent that such predictions are based only on past charitable giving statistics.

  • A phase out of the Transfer Tax system would create enormous uncertainty in tax planning because of the risk that the government in the future could deem it appropriate to stop the phase out of the Transfer Taxes. Because of this uncertainty, the proposed repeal would likely significantly curtail charitable planning for the next 10 years.

Conclusion

There are many arguments on both sides of the debate over legislation to repeal the Transfer Tax system. Both sides tend to mention fairness. However, an analysis of whether the current Transfer Tax structure is fair or not depends on who is doing the analysis. It is difficult to find an absolute standard to be used to define fairness. Eventually, both sides may conclude that reform of the current system is a better alternative. There does appear to be a fairly widespread consensus that the current Transfer Tax system needs some changes.

Of course, one of the main concerns of charities is whether or not the changes proposed would be good for charities and charitable giving. Once again, there is no clear cut answer to this question. As noted above, the impact of the proposed changes may be felt differently among different types of charities. To make the analysis even more complicated, charities also have to be concerned about the conflict between supporting the retention of a Transfer Tax system that primarily impacts the wealthy who make some of the largest charitable gifts and supporting the repeal of this tax when such repeal could be harmful to the interests of those persons the charities are trying to help.

Whether or not there is ultimately a repeal of the Transfer Tax system, we should continue to promote increased incentives for charitable giving in the income tax code. Such incentives could include charitable deductions for taxpayers who do not itemize their deductions, a charitable deduction limit of 50% of adjusted gross income regardless of the type of asset given, an unlimited carryover period for unused charitable deductions during an individual's life and provisions allowing individual retirement accounts and similar retirement plan assets to be rolled over to charity on a tax-free basis. Provisions such as these would help to maintain charities on an even playing field even if the incentives for charitable giving in the current Transfer Tax system are eliminated. 8


  1. H.R. 8, 106th Cong., 2d Sess. (2000) and H. Rept. No. 106-651, 106th Cong., 2d Sess. (2000).back

  2. See 2000 TNT 137-3.back

  3. See, e.g., CCH 2000TAXDAY, Item No. C.2 (July 18, 2000) (Quoting the remarks made by House Majority Leader Richard K. Armey, R-Tex., during the CNN program, "Late Edition," on July 16, 2000, after noting that President Clinton has stated his plan to veto H.R. 8: "We would have the votes to override his veto in the House of Representatives; I'm not sure they would have them in the Senate. Nevertheless, Congress is committed to eliminating estate taxes. It's just wrong to steal a family's lifetime of earnings and accumulation away from their children. So if the president does veto it ... then we would bring it up again in the next session.").back

  4. H.R. 8, 106th Cong., 2d Sess. (2000) and H. Rept. No. 106-651, 106th Cong., 2d Sess. (2000).back

  5. See 2000 TNT 148-13.back

  6. See Staff of Joint Committee on Taxation, Report on Background and Issues Relating to Carryover Basis (Dec. 9, 1979).back

  7. Id.back

  8. See C. Teitell, Taxwise Giving (June 2000).back

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