Hearing Held on Federal Estate Tax
The Senate Finance Committee held hearings on November 14, 2007, concerning the federal estate tax. Iowa Senator Charles Grassley (R-IA) testified, as did Committee Chair Baucus (D-MT). Also testifying were Warren Buffet and Eugene G. Sukup, Chairman of the Board of Sukup Manufacturing of Sheffield, Iowa. Senator Baucus stated that he supports repeal, but also acknowledged that the “tale” of the tax is worse than its actual bite and that very few estates are actually subject to the tax noting that only three in one hundred small businesses end up with any estate tax liability.
Senator Grassley stated that the estate tax applies at death to “take a cut of what that person had worked their whole life for, and has already paid taxes on at least once.” But, that may not necessarily be true. Even if it were true, the decedent’s lifetime taxes, as a proportion of income, could actually be quite low. For example, the decedent may have inherited the property with a stepped-up basis on all the assets, and then merely lived off the earnings of the property. Taxes may have been very low (maybe entirely at the capital gains rate) or zero (if the estate consisted almost entirely of items producing excluded income). With inherited wealth, most of it may have actually escaped tax across several generations. Indeed, at least one academic study has shown that, for the largest estates, more than half of the value of the estate property has never been taxed.
Senator Grassley also referred to the federal estate tax as the “death tax” and stated that death is a poor time for taxation. But, of course, the federal estate tax is not a “death tax.” Death doesn’t’ trigger the tax. If that were true, then all estates would owe federal estate tax to some degree at death. But, only about one percent of estates presently pay any federal estate tax. Also, death is probably the best time for taxation - the decedent can’t use the funds anymore, and death is clearly a point of transfer that is typically thought of as realization event because the government “partnered” with the decedent during life, enabling the estate to grow as much as it did during the decedent’s lifetime. So, it is reasonable to expect the government to receive a share when the decedent dies, if the estate is sufficiently large. Also, the estate’s beneficiaries haven’t had control of the estate assets during the decedent’s lifetime, so whatever they receive is a windfall (even if they think they are entitled to continue any business their ancestors may have started).
Senator Grassley also complained that those inheriting large estates don’t get to choose the timing of their inheritances and, thus, don’t get to time the market when selling assets – claiming that the free market determines when others sell assets. But, the free market simply doesn’t work that cleanly. Death is an event in life that largely cannot be predicted with any degree of accuracy, just like many events that can disrupt the market right before a sale is to occur. Just ask a home seller in the current market in many areas of the country whether they should have put their home on the market during 2006 rather than 2007. Stock prices can also change rapidly (just look at the past few weeks), and estates don’t have to sell assets in a single day – the estate tax isn’t due until nine months after death, and the executor can make an election to pay the tax in installments over 15 years (and the effective federal estate tax rate is quite low anyway – only about 15-20 percent for the largest estates).
Senator Grassley went on to state, “As most people are not privy to exactly when they will hand over half of everything they own to the government, the death tax is fundamentally unfair.” The Senator knows that statement is not correct – he knows that estates don’t pay over “half of everything they own to the government.” So, the statement is misleading. Almost 99 percent of all estates don’t have any federal estate tax liability. For the miniscule number of estates that owe federal estate tax at death, there are numerous estate planning strategies and exemptions that can be utilized.
The basic gist of Mr. Sukup’s testimony concerned why 99 percent of estates that don’t pay federal estate tax should pay additional tax (either in the form of loss of complete stepped-up basis at death or by higher income or payroll tax to make up the $24 billion in revenue that the federal estate tax generates each year) to help his family from paying any federal estate tax. Sukup started a business 44 years ago, and his sons are now part of the business that employs 350 people and sells products in the U.S. and 50 other countries. Sukup testified that the company is a significant benefit to the community and gives a good amount of its profit to charitable causes. Sukup claimed the community would lose if his business was closed down, and claims that his sons would probably have to liquidate the business if he and his wife died because an estate tax obligation of about $15-20 million would be triggered. Sukup noted that estate planning could avoid the tax, but that would prevent even more expansion of the business. Sukup concluded his testimony by stating that he built the company and the federal estate tax would destroy it, and that is unfair.
Are Sukup’s comments on target? They aren’t even close. Even when estate tax rates were higher than presently and the exemption was lower, estate tax opponents found it difficult to come up with any real businesses that had actually been liquidated to pay the federal estate tax. Indeed, most successful businesses make good collateral for loans. So, the Sukup boys could take out loans to pay any actual estate tax obligation, and pay those loans off over time from the business’s cash flow. As for planning, if a business is making millions annually (Sukup claims it is) and doing well, it would certainly be reasonable to plan for future liabilities. Successful businesses do that every day. So, there is no reason that the estate tax should be criticized because it requires planning that is similar to the planning that businesses undertake for other contingent, uncertain, but expected liabilities. Also, large, mega-sized businesses are not necessarily good for a community. Sometimes it may be best if a business is broken up into numerous smaller businesses.
Sukup’s testimony assumes that his family should always be able to run the business that he started. But, why? Sukup also claimed that he has been a benevolent donor to Iowa and local charities, and implies that would end if he had to sell the business to a buyer to pay federal estate tax. But, again one must ask why? Couldn’t another owner be just as interested in the community? As for Sukup’s claim that the federal estate tax discourages entrepreneurs, apparently it didn’t discourage him. He developed a new business and made it successful in the face of an estate tax (an estate tax that, historically, has been at a much higher rate and had a much lower exemption than under present law).
Here’s the bottom line. The Congress has created tremendous uncertainty in planning with the current status of the law on the federal estate tax. But, that should not be a reason to repeal the tax on the wealthiest in society. The Congress needs to find a reasonable middle ground – set the exemption somewhere between $3.5-5 million per decedent (and index it for inflation), drop the rate if necessary, and retain complete step-up in basis at death. The sooner the Congress takes action on the federal estate tax, the better. But, don’t expect much, if anything, until 2009.
» Download Senator Baucus’ testimony: Baucustestimony.pdf
» Download Senator Grassley’s testimony: Grassleytestimony.pdf
» Listen to Warren Buffet’s testimony: cnbc.com/id/21791804/site/14081545
» Read Eugene G. Sukup’s testimony: Sukuptestimony.pdf