Estate Tax Debate Is Not All About The Wealthy
Estate tax is the government grab of part of the transference of wealth generally from one generation to another. It is a tax imposed on the transfer. Merely by passing assets from one to another creates a taxable event. Some call it the “Death Tax”.
The debate rages over whether or not, and how much should be taken by government when a wealthy person dies. It ranges from the Marxist originated extreme of complete government confiscation of all property at the time of death to zero estate tax. We have landed somewhere in the middle.
The argument for a very high tax or complete wealth confiscation goes something like this:
The wealthy may have earned the money in their lifetimes, but more than likely have oppressed other people and broke rules to get there. They are only rich because others are poor. It just is not fair for them to be able to hand over everything to their kids. The children did little or nothing, lived a privileged life, and have no right to their parent’s money when so many other people need it. Others should have the same chance at life, therefore a large part, or even all of their the assets should go to government to redistribute fairly to those who weren’t lucky enough to be born into wealth.
Lets take this argument at two levels: The first one is from the estate of a business owner who built or even inherited his own business; the second from a lazy trust fund baby who inherited wealth and never worked a day in his life, like a Kardashian.
Keep in mind that many states have no estate tax, but for those who do it can be serious as some have a much lower minimum taxable threshhold before they start their money grab.
The following states have no estate tax. If you don't live in one now, I suggest you pick a warm one and move. I chose Florida - because we have no state income tax either.
- Albama
- Alaska
- Arizona
- Arkansas
- California
- Colorado
- Florida
- Georgia
- Idaho
- Indiana
- Kansas
- Louisiana
- Michigan
- Mississippi
- Missouri
- Montana
- Nevada
- New Hampshire
- New Mexico
- North Carolina
- North Dakota
- Ohio
- Oklahoma
- South Carolina
- South Dakota
- Texas
- Utah
- Virginia
- West Virginia
- Wisconsin
- Wyoming
OK - estate tax debate rages on - - -
BUSINESS OWNER DIES
$61 MILLION DOLLAR ESTATE VALUE
In this example, a business owner dies owning a profitable company that manufactures high tech electronic gizmos. The deceased owned it outright. The company is worth $61 million dollars, has no debt, and employs 250 people.
Many believe that an estate tax of 50% over a certain level, say $11 million dollars is fair. After all, isn’t $11 million dollars enough for any family to inherit? Currently congress just raised this this minimum from just over $5 million to $11.2 million. More is better when speaking of tax exclusions. States have their own ideas about how much should be able to be passed on without tax, many states start taxing at only $1 million - that is barely a nice house and a bank account.
Back to our deceased under today’s federal exclusion rate. What happens in this case if the children inherit this business and the exclusion is $11 million?
If taxed at 50%, (Current federal estate tax rate is 40%, some states go as high as 20% - 50% is easy math) the liability to this estate would be half of $50 million dollars or about $25 million dollars. ($11 million excluded, taxed on the rest) Again, you say, - “Oh, cry me a river, the heirs get $36 million, ($11M exclusion + $25M after tax) that is more than enough.”
Well, remember this is a company that makes electronic gizmos. They have competitors who make similar products. The estate must find $25 million dollars in cash somewhere to pay the estate tax. Since the company does not have that kind of liquidity, the heirs have a couple of obvious choices.
OPTION 1:
BORROW MONEY TO PAY ESTATE TAX
This option puts a HUGE squeeze on cash flow. A company without debt is much stronger and easier to manage than one with a large monthly nut. This debt has to be paid somehow, and most likely will be paid from cutting expenses elsewhere. Eliminating 50 or more employees and forcing the other 200 to work harder to try to produce the same output is often tried. This is unlikely to be successful, as 200 people usually can’t do the work of 250, especially if the company was well managed to begin with, - and it probably was. If they can somehow do the work, they certainly won’t want to and will believe it is unfair to expect them to do so without additional compensation – and they would be absolutely right.
By being forced to take on this debt, cutting employees is the inevitable next step. Profit must decrease as the company net income is reduced due to the additional cost of debt service and reduced production because of fewer employees. The company pays less income tax because of the lower net taxable income, the terminated employees can’t pay their own mortgages until they get another job, so they also pay less tax. The newly unemployed employee becomes a drain on government for unemployment benefits and other goodies that may be had.
If the company is forced to take on debt to satisfy estate tax obligations, there is no possible way it can be as profitable. The estate tax is not just about leveling the playing field for the poor by redistribution of wealth through government conduit, it is about keeping the economy rolling, and maintaining jobs.
Side note here. If government confiscates wealth at death, the incentive to accumulate massive wealth diminishes, Why would anyone amass more than they could possibly use in a lifetime if at death it transfers to government? This alone would lead to an economic slowdown because whether we like it or not, we are all human and subject to human nature’s innate instincts. Human nature drives us to succeed for ourselves, our families and maybe our friends. It does not motivate us to provide wealth for government redistribution to people we don’t even know. The more the government forces us to relinquish the fruits of our labor, the less we are willing to produce. It is just human nature.
OPTION 2:
SELL THE COMPANY
If the heirs decide to sell the company, they will of course be fine. They will retain about $30 million after tax and go on to have a great life. But here again, what about the employees? What happens to them?
If the new owner is flush with cash, he may be able to go on as before, maybe they don’t miss a beat, but this is unlikely. If the new owner had that kind of cash, he isn’t likely to want to risk it. Smart investors know, it is a lot better to risk someone else’s money rather than his own – so he will probably want to finance it anyway.
Most large and small business purchases do involve debt – so instead of the heirs owing large bank notes, the new owners will likely owe it instead. This will result in the same types and magnitudes of expense cuts.
If we don’t care at all about the heir’s loss in value to an estate tax, we can’t ignore the reality of the increase in unemployment estate tax causes when a deceased business owner of a once thriving small business passes from this world.
RECKLESS SPENDER / IRRESPONSIBLE DOPE
$61 MILLION DOLLAR ESTATE VALUE
What about the obnoxious, rich, lazy man who inherited all of his money, runs no business, but just spends it irresponsibly on luxuries the rest of us can’t afford, like yachts, expensive cars, beach houses, and French villas? His Daddy left him $200 Million in a bank account, after spending down the $1 Billion dollars his father had left to him. The heir is such a moronic, reprehensible loser, he has only $61 million left. He has no higher purpose in life, he just flaunts his unearned wealth and looks down upon the rest of us as if we were crap on his expensive Italian loafer heels. Shouldn’t his estate be taxed?
Lets look at this from a purely socialistic viewpoint. Will government do a better job for the people with the money than the heir of this lazy, hedonistic man-child who is even more selfish and irresponsible than his father? Let’s assume the heir will completely waste the money on frivolity, just as his father before him had done.
What would government do?
If the government receives $25 million in tax from this estate, what do they do with it? Will it go directly to people most of us might believe can really use it, and maybe even “deserve” it? Will a single mom with 2 kids working at Walmart get a $25K check along with a thousand other deserving people to pay some overdue bills or maybe buy a much needed new car? No. Government collects the money, then puts it into their huge money bucket. Administration and bureaucracy will eat up most of it before it gets to any ultimate destination.
Another point to consider: Government employees now earn roughly 80% more than their private sector employee counterparts. To give them more money only enables them to further widen that gap.
There is a way to help contribute to those struggling in a more direct way.
The rich, lazy trust-fund-adult-baby-snob will do better with the money than government, even when they squander it on what most of us would consider to be wasteful and irresponsible things. Every time he spends more of it, someone becomes a little wealthier. When he buys that expensive car, maybe the salesman gets a bonus, and he pays slightly more income tax, as does the dealer as the profits increase. To the car salesman, he did not waste his money to buy his fourth unnecessary luxury car. The dealership feels the same way.
When he crashes that expensive car in a drunken binge, the repair shop makes money on the repairs, and more income tax is paid. (the auto insurance company may lose a bit, but they will raise his rates and get it back.) To the repair shop, he spent his money wisely on the repairs.
When he appears in court with his attorney to fight the DUI, he pays his court fines. The police officer who handled the accident gets over-time pay for his court appearance, and his attorney collects his fee. Both pay some extra tax here too. The attorney buys an expensive new watch, and the cop goes out to eat with his family – further spreading the wealth.
When he buys that 60 foot yacht and hires a captain to sail him around the world, and a waiter to serve his lazy ass drinks all day long - you can see where this is going. The money winds up in circulation to others to an even greater extent when the lazy, irresponsible heir gets hold of it and wastes it.
Neither the attorney, car or boat salesmen, repair shop, nor the cop or the boat captain, or anyone else on whom he foolishly spends his money believe the lazy heir spent it recklessly. We believe he did, but we can take solace in the knowledge that those upon whom he spent it now have the opportunity to re-spend much of it more responsibly.
Lazy heir puts some in the bank
If the heir deposits a sizable chunk into his bank account, what happens then? - Well he earns some interest on it, on which he will be taxed, and much of the rest is used by the bank to lend to others who will buy things that will also stimulate the economy. A farmer borrows money for a new tractor; A small business needs money to expand; a young couple buying their first house. All of these financial activities are taxable transactions in one way or another. And don’t forget the bank – they earn more on his money than they pay him in interest or they wouldn’t do it, and so they are able to hire another loan officer.
All inherited money eventually finds it’s way into the private sector where much it will be taxed over and over many times again. Very likely this will amount to a lot more than a $25 million immediate drop into the estate tax bucket as it circulates, expands and multiplies.
As money circulates from one sector of the economy to another, each transaction results in some of it winding up in the tax coffer buckets – eventually it will mostly all disappear entirely into that black hole that is Washington, D.C., but over time many more people benefitted from it along the way.
An estate tax gets it into that abyss immediately, without the benefit of circulating and growing it first.
Eliminate the estate tax - not for the good of the wealthy, but for benefit of the little guy.
CHRISTOPHER M. BARRA, MS, EA