Estate Tax Gutted by Loopholes

In 2012, the nation’s estate tax collected just $8.5 billion – a fraction of one percent of the $1.2 trillion of accumulated wealth that passed to heirs. A dozen years earlier, in 2000, the estate tax recycled nearly five times more money back into society ($40 billion – after adjusting for inflation).  

In 2003, 73,100 estate tax returns were filed. Of the 2.5 million Americans that died in 2012, just 9,400 estates filed estate tax returns, and of these, fewer than 4,000 paid any tax.

What’s caused these dramatic changes?

First, the Jobs and Growth Tax Relief and Reconciliation Act of 2003 established a ten-year phase out of the nation’s estate tax. Faced with the prospect that in the eleventh year, the estate tax rate and exemption would snap back to 2003 levels, Congress permanently changed the estate tax in the American Taxpayer Relief Act of 2012 (ATRA), known more popularly as “the fiscal cliff deal.” Under the terms of ATRA, the estate tax exemption was set at $5 million per person ($10 million per married couple) and indexed for inflation. Because of the inflation adjustment, married couples today can exempt $10.7 million from estate taxes. ATRA also lowered the maximum estate tax rate to 40 percent, down from 55 percent before the 2003 tax cut law was passed.

Second, aggressive use of trusts has allowed wealthy individuals to shelter their assets from estate taxes for generations and in some cases, centuries. (South Dakota has been a popular state for establishing trusts because the state allows trusts to continue in perpetuity and imposes no taxes on trust income). Trusts have an important role to play in protecting assets or ensuring that assets are used for an intended purpose, like paying the health care expenses of a special needs family member or setting aside educational funds for a child or grandchild. But increasingly, trusts are being used for the primary purpose of avoiding inheritance taxes. Except in cases where estate planning occurs too close to the date of death, virtually all estates can be fully sheltered from estate taxes with careful planning.

Clever estate planning allows wealthy people to establish trusts that are taxable to the donor for income tax purposes, but to the heirs for estate tax purposes. Hence, when a wealthy benefactor dies, his or her assets pass to the heirs without taxation until those heirs die.

The most problematic trust is the Grantor Retained Annuity Trust, or GRAT. Ironically, Congress passed the GRAT law in 1990 to close another loophole in the estate tax code exploited by tax attorney Richard Covey. But it wasn’t long before Covey found an even bigger loophole in GRAT. This single loophole has cost the U.S. Treasury more than $100 billion since 2000, about a third as much as the total estate taxes collected during the period, according to Covey. Casino mogul and top Republican campaign contributor Sheldon Adelson has used 30 GRAT trusts to give nearly $8 billion to his heirs, saving $2.8 billion in gift taxes since 2010, according to SEC filings analyzed by Bloomberg News.

The estate tax was adopted in 1916 as a tool in the fight against the widening economic inequality of that age. At the present time, as inequality reaches levels not seen for a century, it is time for Congress to close estate tax loopholes and restore trusts to their proper roles by ending  trust fund abuse.

Chuck Collins and Bill Gates, Sr. (father of the founder of Microsoft), co-authors of Wealth and Our Commonwealth, had it right when they called the estate tax the “economic opportunity recycling tax.” Great pools of wealth would not be created without tremendous public investment and support in successful enterprises, and at the end of life, some of that wealth should flow back into the pot that is used to create similar opportunities for generations to come.