Scott McCulloch is Editor of Families in Business magazine.
More and more heirs to small family businesses will find themselves forced to sell those businesses to pay estate taxes, a new report from the Heritage Foundation suggests. The estate tax exemption – the amount below which estates are not taxed – has not changed since 2001, when it was set at US$675,000. And $675,000 "does not a rich man make in 2004," says Gary Robbins, a visiting fellow in Heritage's Center for Data Analysis.
This, adds the conservative Washington DC think tank, is particularly true when assets include business equipment and real property – neither of which can be easily liquidated to pay taxes.
"The problem is that all taxes are paid out of income," says Robbins. "Even if the estate tax is a rare event – once in a lifetime – the average impact is large enough that the combined effects of income and estate taxes approach 100%. So if a person will pay 55% of the principal of any investment in estate taxes on top of income taxes, that sends a clear message – don't invest, consume."
By taxing estates of wealthy people who plan to leave assets to their heirs, the US encourages them to instead give their money away tax-free to, say, foundations, churches or museums. The estate tax, or death tax as it is also known, is slated to disappear for a single year – in 2010 – and some legislators and economists are pushing for permanent repeal. They say taxing estates of the richest Americans takes away funds to create new businesses and wealth.
Robbins calls the tax "a monument to inefficiency that distorts economic activity" and recommends that lawmakers scrap it before it begins to ensnare Americans of decidedly moderate incomes.
The tax, set up to help finance the US military during the first world war, had an exemption of $50,000 in 1916, which equals about $11 million in today's dollars. It reached $14 million in today's money in 1931 but then began to fall. It bottomed out at $356,000 in 1976 and has grown since.
But repealing the estate tax beyond 2010 would leave two giant legacies. For one, it would cut $80 billion a year from Uncle Sam's tax coffers. And because the wealthy give away money to avoid estate taxes, it would sharply diminish charitable giving, says John Irons, an economist with OMB Watch, a Washington DC group pushing fiscal responsibility.
Short of repeal, says Robbins, the exemption should be raised to at least $5 million and converted from a credit to a deduction. But total repeal is unlikely, says Joel Friedman, an economist at the Center for Budget and Policy Priorities, a liberal Washington consultancy. Opposing Democrats have been joined by enough moderate Republicans in the Senate to make it unlikely that the 60 votes necessary to overcome a filibuster could be obtained. And with the US deficit likely to exceed $500 billion in fiscal 2004, legislators will be keen to shore up tax coffers.
More likely is a compromise, says Craig Wruck, a government-relations official for the National Committee on Planned Giving. He believes Congress will end up making $5 million or so of an estate exempt from taxation.