New wealth is making 'death tax' hit home

Next generation faces a burden of prosperity

USA TODAY, January 25, 2000
By Owen Ullmann
USA TODAY

Taxes aren't popular to begin with. But of all the ways Uncle Sam takes a cut, none may be detested more than the tax levied on an estate after someone dies.

The idea of the government reaching into the grave and grabbing 37% to 60% of the wealth accumulated during a lifetime is, well, ghoulish to many. It's the depressing confluence of the only two things in this world that Benjamin Franklin noted were "certain."

"Death itself should not trigger a tax," says House Ways and Means Chairman Bill Archer, R-Texas, a staunch opponent of the levy. "The American people think it's unfair."

Although polls show the estate tax is loathed by solid majorities of up to 70%, a decades-long effort by business and farm groups to abolish what they deride as the "death tax" has failed.

Why? In large part because hardly anyone has any actual experience with the 84-year-old tax. In recent times, little more than 1% of estates have been hit. For 1999, an inheritance would have had to exceed $650,000 for the tax to kick in. Horror stories about business breakups blamed on the tax involve fewer than 10,000 family-owned firms and farms each year, a tiny fraction of the USA's 24 million businesses.

But the economics and politics of the estate tax are about to change.

The booming stock and real estate markets since the early 1990s are creating wealth at an extraordinary rate. That trend is adding trillions of dollars to the vast amount of wealth that is being passed on to a new generation of heirs during the next 20 years. The bottom line is a big jump in the number of families affected by the estate tax, which could provide a groundswell of popular support for burying, or at least easing, the tax.

From 1998 through 2018, the parents of baby boomers and some aging boomers themselves will leave estates worth a mind-boggling $12 trillion to $18 trillion, the largest generational transfer of wealth in history, a study in 1999 by the Social Welfare Research Institute at Boston College concludes. According to the study, that enormous wealth transfer will include as many as 2.8 million estates worth $1 million or more over the next 20 years. The number of people hit by the tax has been climbing steadily since 1990, when 23,215 estates, 1% of all deaths that year, were affected. That is expected to more than double this year to 51,700 estates, or 2% of all deaths, according to the Joint Committee on Taxation. If the Boston College study proves accurate, the number of taxable estates could double again to more than 100,000, or 5% of all deaths, by 2017.

Republicans, who have long sought to abolish the estate tax, are making the issue more prominent in the 2000 campaign. Although GOP calls for big income tax cuts haven't resonated with voters during these prosperous times, proposals to abolish the estate tax seem to strike a chord. "No taxation without respiration," publisher Steve Forbes often declares on the campaign trail to cheering audiences.

When presidential candidate George W. Bush unveiled his five-year $483 billion tax cut plan in Iowa last month, the loudest applause came when he called for the elimination of the estate tax, says the Republican front-runner's top economic adviser, Lawrence Lindsay.

People who don't have enough to pay the tax oppose it nevertheless because it runs counter to their dreams of striking it rich and passing the wealth on to their children.

"If someone earns money honestly and pay taxes honestly, that person should decide what to do with the money, not the government," Lindsey says.

Bush's GOP rivals also want to scrap the tax except Arizona Sen. John McCain, who would raise the exemption to $5 million.

By contrast, Vice President Gore and former New Jersey senator Bill Bradley, the Democratic contenders for the White House, support the status quo. So does President Clinton. Last summer, he vetoed a Republican tax-cut bill that included a phaseout of the estate tax.

Defenders of the tax say it isn't all that onerous. Is it an injustice if heirs born into a prosperous family have to settle for a windfall of, say, $3 million instead of $5 million? What's more, repeal would benefit only the richest 1% of Americans and force lower-income Americans to make up the lost revenue, defenders say.

Larry Rabun of the accounting firm Deloitte & Touche says some of America's wealthiest families - including the Vanderbilts, Rockefellers, Mellons and Carnegies - used elaborate trusts to avoid the tax for generations. But their shelters will expire soon. "If you repealed it, a lot of great wealth would get a free ride," he says.

But some multimillionaires facing the tax insist that they are rich only on paper. New York University economist Edward Wolff estimates that there are 2 million millionaires whose wealth stems mainly from a business or real estate other than a primary residence.

Take Robert Sakata, 42, a vegetable farmer from Brighton, Colo., 20 miles north of downtown Denver.

Back in 1944, Sakata's father, Bob, and other family members paid $6,000 for 40 acres to farm. When they bought more land six years later at $700 an acre, neighbors thought they were crazy to pay so much.

Today, the elder Sakata, 73, owns 2,000 acres just 15 miles from the new Denver International Airport. Its worth: $380 million, based on what a developer recently paid for some nearby farmland. "Yeah, there are a lot of zeros when you add it up," the son concedes.

But aside from the land, the family has no other investments. When the father dies, his wife can inherit the farm without paying any tax; spouses receive a 100% exemption. But when she dies, the heirs would get hit with a tax bill of $200 million, based on the current value, which they would have to pay off over 14 years. "Farms can't survive the inheritance tax," the elder Sakata says.

Farmers can reduce their tax bills by stipulating in their wills that the land be used for farming, not sold for development. That would reduce the value of the Sakatas' spread from $380 million to about $20 million. But it also means future generations can never sell out to developers.

If Sakata wants to give heirs the option of getting out of farming, the family would have to pay the higher tax. "I'd have to sell half the farm and lay off a lot of workers who are like family," adds son Robert, who employs 50 people full-time and up to 350 during the summer. "For us, it's a farm, not an investment. We don't live like multimillionaires. We're just trying to sustain a family business."

That's Jean Stinson's lament, too. Her father founded a railroad track manufacturing company in Bartow, Fla., in 1967. But after his death in 1976 at age 48, the family had to shut down a facility in North Carolina and lay off two-thirds of its 110 employees to pay the estate tax.

"It took us four years to recover," says Stinson, 50, vice president of R.W. Summers Railroad Contractors. Now she's worried about how her son would pay the tax when he inherits her share of the company, which has a current value of $5 million.

"Do I feel like a millionaire? No. Do I live like one? No," she says. "I get up early and work hard."

Besides, she says, the tax is just plain unfair. "We've already paid taxes on all our income. Why should heirs be punished for parents being successful?"

In fact, people avoid some federal taxes when they die, mainly on capital gains. That's why the estate tax is needed to serve as a "backstop," the Clinton administration contends.

Uncle Sam takes up to 20% on the profit someone makes on the sale of stock, bonds, real estate or some other asset. But if someone dies while still holding unsold stock, the capital gain is never taxes. If heirs sell the shares, they pay capital gains tax only on the increase between the date of the benefactor's death and the date of the sale.

For example, if someone paid $10,000 for Microsoft stock worth $1 million at death, the $990,000 profit would escape the 10% capital gains tax. Heirs would pay an estate tax of $120,250 on the $1 million in stock, assuming that was the entire estate. But if they were to sell it years later, they would owe taxes only on gains since they inherited the shares.

Another reason to keep the estate tax, supporters say, is that it helps prevent too much money from being held in too few hands.

"The concentration of wealth in this country is shocking, and it's getting worse," says Boston College economist Alicia Munnell, a former member of Clinton's Council of Economic Advisers. "You want to make the race as fair as possible."

But if the goal has been to spread the wealth more evenly, it hasn't been successful. The richest 1% account for 40% of the nation's wealth today, up from 33% just a decade ago, NYU's Wolff calculates.

"Even if you want to play Robin Hood, it's not a good way to do it," Harvard economist Gregory Mankiw says.

A moneymaker in times of war

Although the rationale for the estate tax has been the desire to level the playing field for each new generation, the original motive was to raise revenue whenever the nation needed to build up its military.

It was first imposed on a temporary basis in 1797, when a naval conflict with France seemed likely. It resurfaced in 1862 to help pay for the Spanish-American War. When the wars ended, the tax was repealed.

It became permanent in 1916, the same year the income tax made its debut, when money was needed for America's expected entry into World War I. For the last half-century, its contribution to federal revenue has been tiny: just 1% to 2% of total taxes.

Economists have long argued over whether the levy hurts economic growth by taxing savings and encouraging consumption. But there is no evidence to suggest it has had much effect on the economy.

What about the effect on charitable giving? For generations, the wealthy have reduced their estates, ad thus the tax burden on their heirs, by giving to charities both before they die and as a bequest in their wills. Defenders of the levy have warned that repeal would hurt charitable institutions.

But much like the debate over the economic impact, there is no clear evidence that a phaseout of the tax would hurt charities. Studies suggest that philanthropy is driven by many factors, and the tax effect is just one.

Ultimately, the debate about the estate tax comes down to moral issues: Does it force the breakup of family farms? Should it tax some assets twice (saved earnings) and others not at all (capital gains)? Is it vital to keep a few thousand families from owning most of America?

Surprisingly, some advocates for retaining the tax, with some reforms, include those whose estates could be hit hardest.

"People shouldn't be able to perpetuate wealth," says C. Boyden Gray, former White House counsel to President Bush and a multimillionaire heir to the R.J. Reynolds family tobacco fortune, "It's an Anglo-Saxon principle with a long, long history that transcends politics."

David Pankonin, 48, a fourth-generation farm equipment dealer in Louisville, Neb., is sympathetic to that view. "I can see some merit in the argument about a huge concentration of wealth," he says. "But there's a big difference between your net worth on paper and what you really have and how you live."

Many supporters and foes of the tax agree at least some reform is needed, such as linking the tax-exempt limit to increases in inflation, the way income taxes are. Another popular compromise would repeal the estate tax but make heirs pay capital gains taxes on the benefactor's assets. That's the approach Congress took in the tax bill Clinton vetoed last summer. Some economists say that change might increase federal revenue, because there are more ways to dodge taxes on estates than on capital gains.

"This is an issue that clearly is going to be highlighted this year," says Ways and Means chairman Archer. Noting that last year was the first time both houses of Congress voted to repeal the estate tax, he vows to push for it again this year. "It's not going to go away."

Not so long as people still believe in the opportunity to become rich one day. "The American dream is alive, but the death tax flies in the face of it," says Brian Reardon of the National Federation of Independent Business. "It bugs people to find out that you can't take it with you and you can't give it to your kids"

The plain facts on the estate tax

• Federal taxes are imposed on estates that exceed a certain value. For 1999, the first $650,000 is exempt. The exemption goes up to $675,000 for 2000 and 2001; $700,000 for 2002 and 2003; $850,000 for 2004; $950,000 for 2005; and $1 million for 2006 and beyond.
• Heirs may choose to assess the value of an estate on the day the individual died or exactly six months later.
• Surviving spouses never have to pay taxes on estates they inherit, no matter how large.
• The tax rate starts at 18% and rises to 55% for taxable estates worth more than $3 million. As a practical matter, though, the minimum tax bite winds up being 37%, and some estates worth more than $10 million are hit with a 5% surcharge that makes the top rate 60%.
• Family-run farms and businesses that are passed on to younger generations may be entitled to a special $1.3 million exclusion from taxes to reduce the financial burden on them. To qualify, the heirs must have been actively involved in running the business. If they owe taxes, the heirs who run these enterprises have 14 years to pay.
• To keep an estate within the exclusion limit, an individual can give up to $10,000 a year tax-free to an unlimited number of people, from close relatives to strangers. A couple can give $20,000 jointly. Under a 1997 law that ties tax-free gifts to inflation, the limit will rise in $1,000 increments.

Sources: Congressional Research Service, Joint Committee on Taxation, Treasury Department and Deloitte Touche

Wealth and the next generation

The greatest transfer of wealth in history is expected to occur during the next two decades (1998-2017) as baby boomers' parents, and some aging boomers themselves, pass on inheritances. The size of the transfer will depend on the rate by which assets grow after adjusting for inflation.

Surging stock and real estate markets are triggering an increase in the number of U.S. households with a net worth of $1 million or more. That means more Americans are likely to be hit by estate taxes when they die.

The government expects estate-tax revenue to jump 63% from 1998 to 2004, more than double the 28% increase for all sources of revenue.

As the size of an estate and the tax bite increase, charities receive a growing share, and heirs' share falls.

Please e-mail us with your comments, death tax horror stories and suggestions on-line at feedback@deathtax.com.

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