Published by Scott Roberts, Director of Estate Planning
The Estate Tax is a tax on the transfer of assets to heirs upon one’s death, or during life when it is called the Gift Tax. With a lifetime exemption of $5.45 million, or $10.9 million per married couple, less than 1% of the population will ever pay it. And yet the tax can still be divisive as some label it the “death tax” and both sides passionately voice their position. On one side are the wealthy (and those who plan to be wealthy) who claim it is an unfair double taxation on assets accumulated through earnings that have already been taxed.
Plus, it is anathema to our American values since it acts as a disincentive to entrepreneurship. On the other side are those who point out that the tax is needed to prevent an unfair advantage to the wealthy who can pass on assets with built-in gains that are never taxed because of the step-up in tax basis at death. Plus, they argue, some reallocation of wealth is needed to prevent an ever-increasing wealth divide, and friction, between the haves and have-nots.
Without delving into the philosophical and macroeconomic arguments for and against wealth redistribution, there are some truths to be highlighted. It is true that the estate tax, in many situations, does represent a double taxation on assets that have already been taxed as income when earned. Of course, it is also true that built-in gains, some very large, are never taxed due to the step-up in basis at death. But if there were a way to address the main arguments of each side on this issue, doesn’t it make sense to explore?
Often, the simplest solution is the best and we need look no farther than to our neighbors up north who have already addressed this very situation. Canada’s estate tax is quite simple: when you die, the transfer of your assets to your heirs (except a spouse) is treated as a deemed sale and any accrued gains are taxed at that time. This approach represents the very epitome of simplicity, effectively dealing with the main arguments of both sides. By taking away the step-up in tax basis and treating the transfer like a sale, the wealthy aren’t able to avoid taxation on built-in gains. And if only the built-in gains are taxed, then there is no double taxation on the wealthy. It begs the question: how have we not done this already?
Part of the answer to that question is that other factors need to be considered also. For example, should there be an exemption for very small estates with built-in gains? Should the rate be the same as the long-term capital gain tax rate, or should it be higher (or lower)? Would such a change have a net negative effect on government revenues? All good questions, among others, that can be addressed in another article. But, at the end of the day, why do we keep tinkering with something anachronistic and broken? Can’t we just answer the implementation questions and formulate a better way, incorporating the simplicity of a deemed sale? I believe we can.
This information is not intended as authoritative guidance or tax or legal advice. You should consult with your attorney or tax advisor for guidance on your specific situation. LPL Financial does not provide legal advice or services.