Why Most People Should Be In Favor of the Federal Estate Tax

I think it is a very easy and popular position to be against the federal estate tax (affectionately known as the “death tax”).  The arguments against the estate tax range from the simple, “the government should death tax it is hard enough” to the bit more sophisticated, “the decedent was already taxed on all earnings and capital gains.”  Despite being a libertarian I think I could even make an argument, albeit a weak one, that there may be societal good in preventing a further concentration of wealth.  It is weak because even with the estate tax there has been an obvious concentration of wealth.  So why should people be in favor of the federal estate tax?  Hint: it has to do with income taxes.

A Simple Explanation of the Federal Estate Taxes

The federal estate tax went through some pretty unbelievable, politically charged, changes in the past 15 or so years.  For purposes of a paragraph within a blog post I am going to focus on the current state of affairs as of March, 2014.  Currently, each decedent can leave up to $5,340,000 to any non-spousal beneficiary.  Spouses may receive an unlimited amount.  So through the use of the portability statute and certain types of testamentary trusts a decedent can leave up to $10,680,000 without incurring any estate taxes.  The number becomes MUCH higher if one is working with a reputable financial planner or estate planning attorney. After that amount the tax rate is an effective 40%.

Want to know how many estate tax filings there were in 2012?  9,400.  Want to know how many people died in the US in 2008? 2,400,000.  There were more cases of TB in 2012 than there were estate tax filings.  The odds that you or anyone you know will be hit with the Federal Estate Tax are slim at best and are even lower than slim if you don’t live in Illinois, TX, NY, FL or Cali, which have the highest filings.

But Evan, I care because taxing someone at death is still wrong.

The Capital Gains Tax is Tied to the Estate Tax

Say what? But you said I wasn’t going to get hit by the federal estate tax.

When someone dies they get a step up in basis on their assets.  Investopedia defines step up basis as,

The readjustment of the value of an appreciated asset for tax purposes upon inheritance. With a step-up in basis, the value of the asset is determined to be the higher market value of the asset at the time of inheritance, not the value at which the original party purchased the asset.

An example

  • Dad buys 10 shares of ABC Stock worth $1
  • ABC appreciates to $100/share – so the account has increased in value from $10 to $1,000
  • Dad dies and leaves this account and other assets totaling $100,000 son
  • Son sells shares the day after dad dies
  • What does he pay in a capital gains? Nothing
  • What does son pay in estate taxes? Nothing

That step up in basis exists as a direct tie in to the estate tax.  In 2010 when we didn’t have an estate tax we had a modified step up which only provided $1,300,000 of step up to be applied.  There is no guarantee we would get a modified system.  In our example above without a modified step up son would owe a capital gains tax of $1,000 minus dad’s original basis of $10 (or $990 x cap gains rate – 15%/20%).

If there is a total repeal of the estate tax there is likely to be at least a partial repeal of the step up basis rules which will affect a whole hell of a lot more people than 9,400…and THIS IS WHY MOST PEOPLE SHOULD BE IN FAVOR OF THE FEDERAL ESTATE TAX.

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