The ‘Death Tax’: It’s Not Certain for Everybody

President Clinton’s veto of the estate tax repeal, and Congress’ failed override attempt Thursday, are sure to be campaign fodder this fall. Before we make up our minds about the potential death of the death tax, however, we should have a clearer idea about what it does and doesn’t do.

Much has been said, for example, about the levy’s potentially devastating impact on family farms and small businesses.

The estate tax typically takes up to 55% of estates worth more than certain amounts; this year, the limit for most estates is $675,000. Family businesses get special consideration: Up to $1.3 million is exempt, and the bill can be paid over 14 years, rather than by the usual deadline of nine months after death.

It’s true that heirs are sometimes forced to sell farms or businesses to pay the tax because the owners failed to plan. Even those who do plan their estates often wind up paying for expensive life insurance policies, to be held in special irrevocable trusts, just to make sure there’s enough cash available to pay Uncle Sam when the time comes.

On the other hand, relatively few farms and businesses grow to the size at which the estate tax kicks in. The heirs of only 2% of those who die each year face the tax as it is structured now. Far more family businesses are probably killed by incompetent or unwilling inheritors than ever died from the estate tax.

There’s also the notion, often repeated, that the very rich don’t pay the estate tax--that they somehow completely avoid it through complex estate planning arrangements.

It’s true that the estate tax can be avoided no matter how much money you have: All you have to do is leave everything to charity when you die. Few people are willing to go that far just to stiff Uncle Sam.

The estate tax can be mitigated through trusts, gifts made during life to heirs and other pre-death arrangements. Married couples with net worths under the combined exemption limit (two times $675,000, or $1.35 million, this year) often can avoid it altogether with decent planning. Putting $675,000 in a special bypass trust at the first spouse’s death, for example, allows the principal to grow free of estate taxes, so that even more than the $1.35 million combined limit could be passed to heirs. With the exemption limit scheduled to rise to $1 million per person by 2006, the couple could pass $2 million.

But if you have a lot more than that and you don’t want to give the bulk of it away, your estate will face some tax eventually.

The number of people who will be faced with the estate tax is expected to rise, thanks to growing wealth from the stock market, the rise of technology fortunes and other factors. That’s why the price tag for doing away with the tax is estimated at $750 billion in the 10 years after repeal. That’s hardly a negligible sum.

The most compelling reason for opposing the estate tax is that it is unfair to tax the same money twice. People pay income or capital gains taxes when they earn money or sell assets for a profit. Why, the reasoning goes, should they have to pay again after they die?

Add to that the money spent trying to minimize the tax, and you’ll see why affluent people are grumpy. Estate planning can be expensive; creating and administering trusts is no small expense.

But the reasoning behind the tax has to do with fairness. Congress saw the massive accumulation of inherited wealth, and the power that it brought, as a threat to our social, economic and political systems. Although the estate tax was originally created to help fund military spending related to World War I, it was retained as a way to discourage the concentration of wealth.

The states cooperated in this attempt to break up huge family fortunes by requiring trusts to distribute all of their principal after a given period of time. In California, for example, trusts can’t last more than 90 years or so. Wags have noted that such distributions are the surest cure for concentrated wealth, since subsequent generations can be counted on to blow their ancestors’ gains.

Some states now allow perpetual trusts, however. If the estate tax is repealed, that means vast fortunes can continue to grow almost without limit because subsequent generations won’t be able to get their hands on the principal.

Some of today’s wealthy will short-circuit this trend by refusing to pass their gains to their heirs. Warren Buffett and Bill Gates have both been quoted as saying they will give or bequeath most of their money to charity, in part because they’re concerned about the potential effects of leaving too much money to their kids.

Other families, however, are likely to have visions of being the next Rothschilds, Medicis or Fuggers, dynasties that wielded wealth so great they helped dictate the course of nations.

Repealing the estate tax means the rich would almost certainly get richer--some say unimaginably so. Whether that’s a good thing or a bad thing depends on your politics and, perhaps, how much you stand to inherit.

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Liz Pulliam Weston is a personal finance writer for The Times and a graduate of the personal financial planning certificate program at UC Irvine. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, 202 W. 1st St., Los Angeles, CA 90012. She regrets that she cannot respond personally to queries. For past Money Talk questions and answers, visit The Times’ Web site at https://www.latimes.com/moneytalk.

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The State of Estate Taxes

The federal estate tax now kicks in at 37% for estates worth $675,000 and rises from there. President Clinton recently vetoed a House bill that would have gradually reduced the rates until the estate tax was eliminated by 2010. Congress failed to override the veto Thursday.

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Current tax rates on estates are as high as 55%.

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Size of estate Marginal tax rate $675,000 37% $750,000 39 $1 million 41 $1.25 million 43 $1.5 million 45 $2 million 49 $2.5 million 53 More than $3 million 55

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By 2006, estates up to $1 million will be tax exempt.

Under current law, the size of estates exempted from estate tax is scheduled to grow until it reaches $1 million in 2006.

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Year Exempted estate size 2000 and 2001 $675,000 2002 and 2003 $700,000 2004 $850,000 2005 $950,000 2006 $1 million

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Estate tax affects only a small number of returns.

About 42,901 estates paid estate taxes in 1997, the latest year for which figures are available. That represents about 2% of the taxpayers who died that year. Nearly half of the $16.7 billion in estate taxes came from the 5% of estates worth more than $5 million.

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Number Estate size Amount paid of returns Up to $1 million $834 million 19,006 More than $1 million to $2.5 million $4.3 billion 17,606 More than $2.5 million to $5 million $3.4 billion 3,954 More than $5 million to $10 million $2.7 billion 1,414 More than $10 million to $20 million $2 billion 592 More than $20 million $3.5 billion 329 Total $16.7 billion 42,901

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Source: Internal Revenue Service