Proposals to Fix the Current Estate Tax System

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, October 1 , 2000.

Copyright 2000  Robert L. Sommers, all rights reserved.

Part 2 of a 2-part series

Proposals to Fix the Current Estate Tax System

Estate tax proponents argue that the estate tax is highly progressive, affecting only the wealthiest Americans, and an effective method to raise revenue. They also claim that it prevents a concentration of wealth and encourages charitable donations. Critics of the estate tax argue that people should not be taxed twice, once during life and again at death.

According to IRS, the largest 2% of all estates are subject to estate tax. Approximately only one in every thousand estates is worth $5 million or more, yet this group accounts for almost 50% of all taxes collected. The average tax rate is approximately 19% (less than the current federal long-term capital gains rate) when credits and deductions are considered. Those with estates of $2.5 million or less account for 30% of all estate taxes collected at an average tax rate of 12.3%.

With the current appreciation in real estate and stock market values, middle-class taxpayers with a home, stock market investments and retirement accounts are finding themselves subject to estate tax. Estates worth more than $675,000 in 2000 ($1 million after 2005) are currently subject to estate taxes at rates beginning at 37%.


Based on my 20+ years’ experience with estate taxes, the following is my proposal to modify the current law to protect estates within the $1 million to $2.5 million range, lower taxes on larger estates, simplify estate planning and preserve the current stepped-up basis to fair market value rules. Note: All values should be increased by the cost of living index after 2000.

1. The estate tax exemption should be immediately increased from $675,000 to $1 million per person and should increase $50,000 per year for the next 5 years, starting in 2001. Distributions between husbands and wives should retain the full $1 million exemption.

For example: If a husband and wife have a simple plan in which the survivor receives the entire estate and one spouse dies, then that spouse's exemption should transfer to the other who now has a $2 million exemption. Currently, a deceased spouse’s exemption is lost on a transfer to the surviving spouse, which means a couple with a $2 million estate will have a taxable estate of $1 million on the date of the survivor’s death. The exemption for foreigners should be 50% of the U.S. taxpayer's exemption (currently, it is less than 10%).

2. The income tax exemption for a residence should pass to the surviving spouse or to the executor of the decedent’s estate, in which case, the executor could apply the exclusion against the increase in estate taxes caused by the home’s inclusion in the estate.

For example, if the surviving spouse dies when the home is worth $1 million and the estate tax on the home is $300,000, the executor could apply the $500,000 residence exclusion to eliminate the estate tax.

3. The annual gift tax exclusion should be raised from $10,000, set back in 1981 to $25,000, per beneficiary and should include gifts made in trust for the beneficiary. Annual tax-free gifts of an interest in a small business or farm to family members should be increased to $50,000.

4. The value of small businesses and farms should be reduced by 50% ($1.5 million maximum reduction), if they are transferred to family members with the requirement that they be operated by them for at least 5 years.

5. Life insurance proceeds used to pay estate taxes should not be considered part of the estate. In other words, if the decedent had a $1 million policy and $750,000 was used for estate taxes, then only the $250,000 that passed to beneficiaries should be part of the estate. This would eliminate the complicated rules involving irrevocable life insurance trusts.

6. Estate tax brackets should start at 20% for every $1 million of taxable estate, and the top estate tax rate should be reduced to 40%. Thus, the tax on the first $1 million would be 20%, then 30% on the next $1 million, then 40% on taxable estates exceeding 2 million.

7. Transfers of a fractional interest in property or a minority interest in a family business or farm should receive a 30% discount. Under current law, each transfer is subject to appraisals, and often litigation, to determine the appropriate minority discount percentage.

8. All estate taxes could be paid annually over a 10-year period with a 4% interest rate. The estate tax return should be due 12 months after the date of death and extensions should be automatic for another 6 months. Property should be valued at the fair market value on the decedent’s date of death or 12 months thereafter, whichever value is lower.

9. The generation-skipping tax exemption should be raised from $1 million to $2 million per person. Spouses should be permitted to transfer the unused portion of the exemption to the surviving spouse.

10. The current qualified-domestic-trust provision that restrict the use of the marital deduction for property distributed to a surviving spouse who is not a U.S. citizen should exclude U.S. permanent residents (green card holders).

11. Creation of a joint tenancy in real estate should not be considered a gift.

12. The 3-year lookback rule which applies to certain gifts and transfers, most notably, transfers of an existing life insurance policy into trust, should be eliminated.

13. Executors of an estate should have the opportunity to change or make tax elections within 3 years from the date of death.

By implementing these changes, the estate tax would be lower, simpler and more equitable. Thus, husband and wife could make large annual gifts, purchase life insurance to pay estate taxes and leave their property to each other without running into the current gauntlet of rules.



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All contents copyright 1995-2003 Robert L. Sommers, attorney-at-law. All rights reserved. This internet site provides information of a general nature for educational purposes only and is not intended to be legal or tax advice. This information has not been updated to reflect subsequent changes in the law, if any. Your particular facts and circumstances, and changes in the law, must be considered when applying U.S. tax law. You should always consult with a competent tax professional licensed in your state with respect to your particular situation. The Tax Prophet® is a registered trademark of Robert L. Sommers.