AgDM newsletter article, April 2001
* By: Neil Harl, Charles F. Curtiss Distinguished Professor of Agriculture, professor of economics, 515-294-6354, firstname.lastname@example.org
Congress is considering repealing the Federal Estate Tax. Is repeal a good idea? Emotions run high on both sides of the issue.
History of estate taxes
The federal estate tax was enacted in 1916. But taxes on the transfer of wealth were imposed as far back as the seventh century B.C. in Egypt. The first U.S. tax on wealth transfer dates from 1797 (eliminated in 1802) when Congress imposed a stamp duty on receipts for legacies and probates of wills to pay expenses of dealing with French attacks on U.S. shipping. Similar, short-lived taxes were enacted during the Civil War and the Spanish-American War. Nearly all industrialized countries levy some type of wealth transfer tax, varying in detail from an estate tax on wealth left by decedents to some form of inheritance tax on amounts passing to heirs.
Estates subject to tax
The number of estates subject to the federal estate tax has been quite modest in recent years. Out of the 2.3 million who died in 1998, only 47,483 estates actually paid federal estate tax. The $20,349,840,000 collected averaged about $425,000 per estate. The tax on estates averaged $2,356,000 in Alaska down to $120,000 average in South Dakota. The top five states in average tax per estate were—Alaska ($2,356,000), Vermont ($786,000), Wyoming ($758,000), District of Columbia ($678,000) and Rhode Island ($605,000). The bottom five states in average tax per estate were—Iowa ($224,000), Nebraska ($203,000), West Virginia ($196,000), Idaho ($182,000), and North Dakota ($120,000).
Farm estates taxed
The precise number of farm estates subject to federal estate tax is not known. What is known is how many estates listed farm property but it is not known whether that was a farm landlord or an operating farmer. In 1998, out of the 47,483 taxable estates that year, in only 642 did farm assets including farm real estate equal at least one-half of the gross estate. Out of the 2.3 million who died in 1998, in only 1,418 estates did family-owned businesses or farms comprise a majority of the estate. USDA estimates that, in 1998, fewer than six percent of all farms had a net worth in excess of $1.3 million. Only 1.5 percent had a net worth of more than $3 million. With some planning, estates of that size can pass free of federal estate tax using the unified credit, the family-owned business deduction, special use valuation for the land and discounting for co-ownership and entity ownership.
Who pays the tax
Households in the top five percent of income distribution bear 91 percent of the estate taxes compared to 49 percent of the income tax. Households in the top 20 percent bear 99 percent of estate taxes and 77 percent of income taxes. About 91 percent of estate tax is paid by individuals with annual incomes of more than $190,000 at death. Estate tax versus income tax Federal estate and gift taxes contributed about $27 billion in revenue in 1999. Income taxation of the gain at death would have produced about $26 billion of extra income tax. Currently most assets held at death receive a new income tax basis with no income tax on the gain. Repealing the Federal Estate Tax may eliminate this new income tax basis provision for property held at death. The current proposal would give each estate $1.3 million of step-up in basis with an additional $3 million for a surviving spouse. Above those levels, the pre-death basis would carry over to the heirs. If estate taxes are repealed, with loss of the new income tax basis at death, the top two percent of decedents’ estates will receive a huge estate tax break that will effectively be paid for (additional income taxes) by everyone up and down the asset scale who inherits property. The 2,400 wealthiest decedent’s estates will have received a tax cut averaging about $3.5 million each. The legislation that passed in 2000 (but was vetoed) would have provided a new income tax basis for property held until death of $1.3 million for each decedent, $3 million for a surviving spouse. Beyond that, property would carry over its old basis into the hands of the heir. This was tried in 1976, and was repealed in 1980, without ever going into effect on a mandatory basis. The calculations were complex and the task required estates to produce income tax basis figures for all assets—even land purchased decades earlier.
Without much doubt, the federal estate tax encourages charitable contributions. In 1997, out of 329 taxable estates with gross estates above $20 million, 182 made charitable contributions averaging $41 million each. Federal estate tax also encourages charitable giving during life as a way to reduce federal estate tax values.
For the farming part of the population, a new income tax basis at death is more important economically than repeal of the federal estate tax. If the relatively few farm estates subject to federal estate tax are viewed as a problem, a modest increase in the amount eligible to pass with no tax should take care of that problem. The huge concentration of wealth in the past decade, which has largely bypassed farmers, is a further reason to retain the federal estate tax.
* This article first appeared in the December 2000 issue of Crop Decisions Magazine.