Interesting Facts on the Estate Tax
The federal estate tax is a tax on property (cash, real estate, stock, or other assets) transferred from deceased persons to their heirs. Only the wealthiest estates pay the tax because it is imposed only on the portion of an estate’s value that exceeds a specified exemption level — $5.43 million per person (effectively $10.86 million per married couple) in 2015.
The estate tax thus limits, to a modest degree, the large tax breaks that extremely wealthy households get on their wealth as it grows, which can otherwise go untaxed. The estate tax has been an important source of federal revenue for nearly a century, yet a number of misconceptions continue to surround it.
1. Roughly 2 of Every 1,000 Estates Face the Estate Tax
Today, 99.8 percent of estates owe no estate tax at all, according to the Joint Committee on
Taxation. Only the estates of the wealthiest 0.2 percent of Americans — roughly 2 out of every 1,000 people who die — owe any estate tax. This is because of the tax’s high
exemption amount, which has jumped from $650,000 per person in 2001 to $5.43 million per
person in 2015. Thus, the estate tax is best characterized as a tax on very large inheritances by a small group of wealthy heirs.
2. Taxable Estates Generally Pay Less Than One-Sixth of Their Value in Tax
Among the few estates nationwide that owed any estate tax in 2013, the effective tax rate — that is, the share of the estate’s value paid in taxes — was 16.6 percent, on average, according to the Urban-Brookings Tax Policy Center (TPC).
That is far below the top statutory rate of 40 percent. Claims by repeal proponents that the estate tax consumes nearly half of an estate’s value are therefore false. The effective rate is so much lower than the top rate for several reasons. First, estate taxes are due only on the portion of an estate’s value that exceeds the exemption level; at the 2015 exemption level of $5.43 million, a $6 million estate would owe estate taxes on $570,000 at most. Second, heirs can often shield a large portion of an estate’s remaining value from taxation through generous deductions and other discounts that policymakers have enacted over time.
3. Large Loopholes Enable Many Estates to Avoid Taxes
Many wealthy estates employ teams of lawyers and accountants to develop and exploit loopholes in the estate tax that allow them to pass on large portions of their estates tax-free. For example, some estates use grantor retained annuity trusts (GRATs) to pass along considerable assets tax-free. The estate owner puts money into a trust designed to repay the estate the initial amount plus interest at a rate set by the Treasury, typically over two years.
If the investment, typically stock, rises in value any more than the Treasury rate, the gain goes to an heir tax-free. If the investment doesn’t rise in value, the full amount still goes back to the estate. Such techniques have been described as a “heads I win, tails we tie” bet. The GRAT loophole enables wealthy estates to avoid extraordinary amounts of tax when stock or
other assets rise in value quickly, as has happened frequently in recent years. The tax lawyer credited with discovering the loophole estimates that it has allowed wealthy estates to avoid as much as $100 billion in estate taxes since 2000, or close to one-third of the amount that the tax raised over the period.
4. Only a Handful of Small, Family-Owned Farms and Businesses Owe Any Estate Tax
Only roughly 20 small business and small farm estates nationwide owed any estate tax in 2013, according to TPC. TPC’s analysis defined a small business or small farm estate as one with more than half its value in a farm or business and with the farm or business assets valued at less than $5 million. Furthermore, TPC estimates those roughly 20 estates owed just 4.9 percent of their value in tax, on average.
Only roughly 20 small business and small farm estates nationwide owed any estate tax in 2013, according to the Tax Policy Center. Those 20 estates owed just 4.9 percent of their value in tax, on average. These findings are consistent with a 2005 Congressional Budget Office (CBO) study finding that of the few farm and family business estates that would owe any estate tax under the rules scheduled for 2009, the overwhelming majority would have sufficient liquid assets (such as bank accounts, stocks, bonds, and insurance) in the estate to pay the tax without having to touch the farm or business.
The current estate tax rules are even more generous. Furthermore, special estate tax provisions — such as the option to spread payments over a 15-year period and at low interest rates — allow the few taxable estates that would face any liquidity constraints to pay the tax without selling off any farm assets.
5. The Largest Estates Consist Mostly of “Unrealized” Capital Gains That Have Never Been Taxed
Much of the money that wealthy heirs inherit would never face any taxation were it not for the estate tax. In fact, that’s one reason why policymakers created the estate tax in 1916: to serve as a backstop to the income tax, taxing the income of wealthy taxpayers that would
otherwise go completely untaxed. Under the current tax system, capital gains tax is due
on the appreciation of assets, such as real estate, stock, or an art collection, only when the owner “realizes” the gain (usually by selling the asset). Therefore, the increase in the value of an asset is never subject to income tax if the owner holds on to the asset until death. These unrealized capital gains account for a significant proportion of the assets held by estates —
ranging from 32 percent for estates worth between $5million and $10 million to as much as about 55 percent of the value of estates worth more than $100 million.
The estate tax also serves as a modest corrective to other tax rules that provide massive tax
benefits to income from wealth, such as the fact that capital gains are taxed at lower rates than wages and salaries. The top 0.1 percent of taxpayers — those with incomes above $3.2 million — will receive more than 50 percent of the benefit of the preferential capital gains rates in 2015, worth about $500,000 apiece.
Other tax rules allow part of the income of the very wealthiest to go completely untaxed, even with the estate tax. Since the estate tax serves, in part, to tax capital gains that have not otherwise been taxed, some people have proposed taxing estates at the top capital gains rate, currently 23.8 percent. This argument is flawed: the capital gains tax rates typically apply to nearly all capital gains income, whereas the estate tax applies only to the part of an estate that exceeds the exemption level. The estate tax’s average effective rate of 16.6 percent in 2013 was below the capital gains rate.
6. The Estate Tax Is a Significant Revenue Source
The estate tax will generate about $246 billion over 2016-2025 under current law, according to
CBO. While this is less than 1 percent of federal revenue over the period, it is significantly more
than the federal government will spend on the Food and Drug Administration, the Centers for
Disease Control and Prevention, and the Environmental Protection Agency combined.
Most budget experts agree that more deficit reduction — on top of the significant measures of
recent years — is needed to address our longer-term fiscal problems as the economy strengthens. Even without the loss of estate tax revenues, deficit reduction is difficult.
7. Compliance Costs Are Modest
The public and private costs associated with estate tax compliance — including IRS costs to
administer the tax and taxpayer costs for estate planning and administering an estate when a person dies — equaled about 7 percent of estate tax revenues in 1999. That is within the range of compliance costs for other taxes. For instance, administrative and compliance costs equal about 14.5 percent of the revenue raised by the individual and corporate income taxes and about 2 to 5 percent of the revenue raised by sales taxes.