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Copyright 2000 Robert L. Sommers, all rights reserved.

October, 2000 Hot Topics - part 2 of a 2-part series

Repeal of the Estate Tax - More Election-Year Hype

A  Self-Interview Regarding the Estate Tax Repeal Legislation

Question: Well Mr. Tax Attorney, I'm sure you are happy with Clinton’s veto of the legislation that would have repealed estate taxes. I guess it is now a "dead" issue for this political season. It looks like you and your estate planning buddies will not be unemployed soon. Too bad!

Answer: This legislation was bad for the public, but it would not have hurt estate planners. To the contrary, I'd call this legislation "Estate Planners Full Employment Act for the Millenium." This legislation, with the resurrection of the unworkable "carryover basis" rules, and selective use of limited stepped up basis rules, would have created huge tax-planning loopholes that would have kept us in business for years.

Remember, estate taxes comprise only a portion of estate planning. Succession planning (who gets the assets and under what conditions), asset protection from creditors and probate avoidance are also crucial elements of estate planning and none of these would have been affected by the so-called repeal. So in addition to performing all the non-tax-planning aspects of estate planning, the proposed legislation would have provided planners opportunities to exploit the new set of rules governing estates – or did you really believe Congress was going to totally eliminate all taxes on asset transfers?

Moreover, this legislation was deceptive on two major counts: It would have eliminated the estate tax gradually over 10 years, which means that for a decade, taxpayers would still need to plan for estate taxes, but more importantly, the legislation would have replaced the estate tax with an income tax on the appreciated assets being distributed to beneficiaries, including surviving spouses.

Question: Ah, the old class warfare distinction. You sound like Karl Marx when you start with the billionaires vs. the middle class. The highest estate tax rate is 55%. That is confiscatory. We are all Americans and everyone wants to be rich. Why do you insist on punishing those who happen to be successful in America. Sounds socialistic to me!

Answer: That’s an old argument. A major premise of the estate tax is to prevent the concentration of wealth in the richest Americans, no doubt about it. The rationale is that the upper 1% of the population already controls 20% of the wealth, even with the present estate tax, and with that wealth concentration comes political power. The estate tax attempts to make sure that Congress remains a chamber of the people and not a house of the rich and privileged. The estate tax, like the income tax, is based on the progressive tax concept: those who earn more should pay a higher percentage of their income and wealth toward taxes.

However, let's talk about reality. The estate tax actually costs the wealthy about 5% to 10% of their wealth, max. Some experts believe the estate tax is voluntary because there are so many opportunities to plan around it. It is really those who refuse to hire a good estate planning attorney who get burned by the estate tax. Unless a wealthy person has been living on Mars, he or she can plan around the tax using a fraction of their wealth. So while the estate tax is nominally 55%, those who have received the proper advice will wind up paying a small fraction of this amount.

Question: You sound like an advertisement for tax and estate planning attorneys. Okay, Mr. Hotshot, how do the wealthy reduce their estate taxes?

Answer:  For starters, many form an irrevocable life insurance trust funded with second-to-die life insurance. These policies pay on the second death, when the estate tax is levied and because these policies take into account both lives, the cost is extremely low - generally between 5% to 15% of the estate tax. Thus, because the estate tax is a known liability, taxpayers can plan to pay it with steeply discounted dollars. For example, if a $5,000,000 estate will have an estate tax liability of $2,500,000, it might cost $250,000 in premiums for a second-to-die policy paying $2,500,000. By purchasing such a policy, the estate tax is effectively paid with $250,000 or 5% of the estate.

For businesses, farms and real estate holdings, formation of a family limited partnership or family limited liability company can reduce the value of these holdings by 30-45%. In addition, annual gifting of assets further reduces the size of an estate.

There are also estate freezing techniques that effectively shift the future grow of assets to the next generation. For instance, if the taxpayer loans money to a venture in which the children are the owners, then the future appreciation will belong to the children. Thus, the taxpayer's estate is frozen in value for estate tax purposes.

Then there is a whole series of charitable giving through trusts that eliminate estate taxes, while allowing the taxpayers to live off the earnings for the rest of their lives.

For most taxpayers, a comprehensive estate plan, including the formation of an irrevocable life insurance trust, might cost $5,000. For more complex estate plans that involve business succession planning and family limited partnerships, the cost might run between $10,000 to $25,000 - a relatively low price for saving millions of dollars in estate taxes. Because of this, I surmise that those complaining about losing their businesses or farms to the estate tax were probably too lazy or frugal to hire proper professionals to protect themselves against the tax. In any event, it is hard to blame the estate tax for their failure to properly plan around it.

Question: It sounds like you are profiting handsomely from the status quo and see no need for change. Do you have any suggestions for reforming the estate tax.

Answer: Yes, there are several very important steps that can be taken to make the estate tax fairer and more equitable. Each provision containing dollar amounts should be indexed annually for inflation.


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.

Question: Sounds like you criticize the estate tax, but then want changes that would essentially eliminate it.

Answer: No, I believe these changes address of some the complicated and inequitable issues surrounding the current tax. The tax rate is clearly too high and the exemptions are clearly too low. Businesses and farms need protection against forced sale because of death. The aim should be to eliminate taxes on estates of $5 million or less, which account for approximately 50% of the estate taxes paid.   Thus, I'm in favor of reducing the overall estate tax, but do not believe it should be eliminated.

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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.