Taxation

Estate and inheritance taxes are imposed at the time of death and are extremely important to affluent elderly persons. The federal estate tax exempts $675,000 of lifetime taxable transfers of wealth, and this amount is now scheduled to rise in steps described in a tax law passed in May of 2001. The first increase is to $1,000,000 in 2002 and 2003, and ultimately the exemption is increased to $3.5 million in 2009. With a modicum of estate planning, couples can double the basic exemption although the new law will impose limits on this privilege in future years. After the exemption is exhausted, a tax rate of 37 percent is currently applied—a rate that gradually rises to 55 percent on taxable estates greater than $3 million, but these rates are to be lowered in the future. The federal estate tax is supposed to disappear altogether in 2010 and then to be reimposed in 2011, but that, as well as scheduled exemptions and rate reductions, could be changed many times before then.

Because of the large exemption, only 2 percent of estates pay the federal estate tax, but that figure greatly understates its effects. Only one member of a couple actually pays the tax, but it is of concern to both. Moreover, many avoid paying only because of judicious planning. Perhaps more important politically, many aspire to be rich enough to be affected, although few will attain the requisite amount of wealth.

For whatever reason, the tax is extremely unpopular and many who have no hope of paying it still regard it as being extremely unfair. Many consider it to be a tax on those who are frugal, hard working, and altruistic toward their descendants. Although special provisions ease the burden of the tax on those wishing to convey farms and small businesses to family members, many do not think that the special provisions are lenient enough and complain that the need to pay the tax forces sales of property. However, such sales are actually extremely rare.

Proponents of the tax praise its progressivity and see it as a tool for extracting taxes from those who have been skilled at avoiding income taxes through their lifetime, either legally or illegally. It is also seen as a device for preventing great concentrations of wealth.

The federal estate tax law now allows a 100 percent credit up to a certain limit against the federal estate tax for estate taxes levied by states. The limit on the credit is related to the taxable value of the estate. Because a state estate tax levied up to the limit does not impose any extra cost on taxpayers, all states impose so-called pick-up taxes that exploit the entire federal limit. The new law gradually reduces these credits and repeals them entirely in 2005.

Thirteen states and Puerto Rico levy inheritance taxes in addition to pick-up taxes, while four states have additional estate taxes. An inheritance tax depends on the size of the bequest left to an individual heir, whereas an estate tax depends on the total value of the estate left by the decedent, regardless of how it is spread among heirs. Estate and inheritance tax rates and basic exemptions vary greatly from state to state and often depend on the relationship between the beneficiary and the decedent, with close relatives being favored.

A strong trend has developed at the state level toward reducing or eliminating estate and inheritance taxes because they are so unpopular politically. In 1989, eighteen states levied inheritance taxes and eight levied estate taxes in addition to pick-up taxes. In January 1999, only fourteen states had inheritance taxes and four still had estate taxes. New York has been reducing its very heavy estate tax by raising exemptions and cutting rates.