Arnie J Olsen
February 26, 2020
In response to one of my recent Facebook posts, I found myself in a debate about the Estate Tax…and yes, I am a glutton for punishment apparently. Well, anyway, my response, while off the cuff, was awfully long and I don’t care to ever have to type all that again, but since I know the argument will certainly come up again (as GOP rhetoric has no limits), I just decided to drop it into a blog article for future reference and wanted to share.
I will also add that I was going to copy and paste the original comment I received, but it seems to have been deleted since I read it and began my response, but if you are at all familiar with the debate, you know what the talking points were:
- Double Taxation.
- Penalizes small family farms and businesses, and prevents parents from handing down their life’s work to their children.
You get the idea.
So, with that said, here is my response. Again, this was a quick off the cuff comment, but I think it still makes the point, and should provide anyone reading this with ammunition to refute the never ending GOP claims.
The estate tax is an interesting subject. The tax we face today was first implemented over 100 years ago, shortly after the 16th Amendment that allowed for a Federal income tax. The thing that I think s most interesting from your perspective is that it was actually under Obama and a democratically controlled Congress that the high exemptions were first implemented, meaning that they are the ones who changed the law so that only extremely wealthy people would be affected by it. By that I mean that they are the ones who passed a $5 million per person ($10 million for married couples) exemption. Prior to that, it was consistently in the $1 to $2 million range throughout the W years.
Anyway, as for the tax itself, and thinking about that married couple that will be taxed on an estate of more than $10 million when they die, I think you are very informed on many of these issues, but that you’re off base on this one…for several reasons.
First, the rhetoric in opposition to this basically boils down to two general complaints. First, it is implied (and many people believe) that it will apply to them. I remember my dad being totally angry about it when he was planning his will and such 20 years ago, with his chief concern being the $200,000 home he owned and had paid for. He went to an attorney and made sure to come up with this whole trust mechanism to make sure that it did not get taxed when he passed away. It was NEVER at risk of being taxed in this way…because it would never have enough value to not be exempt. And when he did pass away a couple of years ago, I had family members in his age group frantically giving me advice on how to avoid the “death tax”. It was amazing to me how many people are convinced that this tax will somehow negatively affect anyone below the 1% or less, but that is GOP propaganda for you. The super-rich convincing the working class those laws are totally unfair to them, as a means of convincing the working class to support the greed of the super-rich. It’s truly mind boggling.
Now, second, for those people that this law will apply to (and I know different states have different laws along these same lines, but I am not going to research each one and do all that math). The common belief among those who are bothered by this law is that these people are being taxed a second time on their wealth that they have already paid taxes on. The only way you would be right about that is if you assume that their wealth was accumulated based on W2 paychecks received over their lifetimes that were subject to withholding all that time, and then held in cash until they died. While it’s certainly true that some people do have a million dollars in the bank, in liquid form, but I think you will find that those people also have a massive amount of wealth outside of cash. Now, to have $10 million in the bank (under the Obama rule) or now, “thanks” to Trump, over $22 million in the bank simply is not going to happen with someone only accumulating taxable income year after year, unless maybe you are a star NFL quarterback or a Hollywood A-Lister for decades. So, the first thing is to rule out the notion that anyone but the top 1% or 1/10th of 1% are even effected by this. Then, let’s think about how that wealth is accumulated over time. Simply put, that kind of wealth is in large part or entirely generated not from saving W2 income that was already subjected to income tax. No, not even close. The two main areas that lead to that kind of wealth are real estate or business investments.
Let’s look at real estate investments first. These are generally purchased via some sort of financing and have income to offset the payments, but even if it is your personal residence that is worth more than $20 million, it was NEVER taxed throughout your lifetime, at least not in the way that an estate tax does. It was purchased (financed most likely), and assuming it is an income property of some sort, it is first depreciated over 27.5 years, so the owner has actually written off the entire purchase price of the real estate and used that to offset whatever W2 income they may have had along the way, so in fact, not only were there no taxes paid on the purchase of the real estate, the value of it eliminated income tax on an equal amount of other income the person may have had, so they are already ahead of the game by paying less in income tax than they would have had they not purchased the real estate. At the same time, every expense that goes into maintaining that real estate is written off of their income tax, as is the interest on the mortgage used to purchase it so the net effect here is that all expenses, including upkeep is paid using “pre-tax” dollars not net income. Now, we can finally get to what the estate tax actually does impact. If there is enough real estate owned to cross above the exemption limit, the amount allowed to be exempted still is, meaning that even under the Obama rule, that allowed $10 million for a married couple, a married couple that owned real estate worth $11 million would be able to pass that on to their heirs with $10 million of that value exempted from the estate tax and it would only be paid on the extra million that exceeded that threshold. More importantly, the reality is that since we are talking about an asset that has appreciated over time, there was zero tax ever paid on that increased value. It was likely used as collateral to secure other mortgages and more acquisitions, but whether it was or not, that “wealth” was never taxed because it is only taxed if you sell, and realize capital gains (which would be taxable if it was not your primary residence and over a certain amount). So, if you have lived your whole life and die before selling, you have even avoided the capital gains tax, so passing it on to heirs is nothing more than treating it as if you had sold it while you were still alive. So, the estate tax is not a “double tax”, it is the ONLY tax paid on that wealth.
The second way you see the estate tax kicking in is frequently on business investments…sometimes it may be the privately held business you started or more often it is based on securities that you have acquired. In either case, your wealth is entirely due to the appreciation of these assets over time, and just like real estate, appreciation is not taxable unless or if you sell the asset when the capital gains tax kicks in again, taxing you on the difference between acquisition cost and current value at the time of sale. You have never paid taxes on that appreciation if you still own it when you die, so again, the transfer to an heir is basically treated no differently than had you sold the asset while still alive. In other words, there is no double tax. The difference here, like with real estate, is that you get a massive exemption that eliminates any tax liability on over $22 million before a penny of tax is paid, and not only does that completely eliminate taxes for most everyone, it also totally offsets the difference between the estate tax and the capital gains tax…except in the most extreme cases of accumulated wealth.
Even the notion that small family businesses are lost rather than being able to passed on to heirs is greatly exaggerated. Family farmers are one of the groups that is most frequently misled by GOP propaganda because they simply do not do that math. I know prices vary, but land is the primary asset of a family farm, and a commonly seen price is about $10,000 an acre. That would mean a farm would need to be over 2,200 acres to be impacted under current law. That’s over 3 square miles. There are not a lot of “family farms” anywhere near that large. In fact, according to the USDA, this is what they say:
“Acreage is another way to assess farm size. According to the USDA , small family farms average 231 acres; large family farms average 1,421 acres and the very large farm average acreage is 2,086. It may be surprising to note that small family farms make up 88 percent of the farms in America.”
So then, let’s look at a different kind of business…say a manufacturing company, as that is a type that would have one of the largest amounts of assets, due to equipment, inventory, etc. A typical business valuation is value of assets, plus 3 times net annual income. A fairly typical net income percent (EBIT) is around 10% (and I have owned and operated a small manufacturing company with 30 employees and a fair amount of equipment, so I am fairly in tune with this model). If you want to assume $1 million in equipment and inventory, which is very much on the high side for companies this size, that leaves $21+ million in net income based value that is offset by the exemption; or $7 million for each of the three year window used in the valuation. That would mean we are talking about a $70 million annual sales company here, and that’s assuming the business has zero debt that offsets that value. With manufacturing, a common factor is that your cost of labor is around 20-25% of annual revenue. That means that “small family business has an annual payroll of around $17.5 million and in headcount terms, that is easily more than 400 employees. Sorry, but that is not a “small family business”, but even a company that large would be entirely exempt under current law.
Lastly, for this to truly be “double taxation”, you would need to assume that all of the money to reach that $22+ million threshold was earned as regular income over the course of someone’s life and they managed to save it, with no appreciation, no returns on investment or anything else, because as I described, all of those gains are never taxed until they are sold. Now, if you assume that someone might spend 50 years of their life working, in order for a married couple to accumulate enough to even approach that exemption threshold (not exceed it, mind you), it would take saving $440,000 each year for 50 years. That is not even “earning” $440,000 for each of those 50 years, but rather, having enough disposable income that after withholdings, and after you pay all of your living expenses, you still have $440,000 left over each year to tuck in the mattress. Now, to actually be forced to pay estate taxes, you would have to EXCEED that amount, and for you to notice the estate tax bill as anything more than change you would find in your sofa (since no matter how much you make, the first $22+ million remains exempt), you would have to earn a SERIOUS amount above that level. How many people do you really think that applies to?
I know that if you adhere strictly to the taxation is theft notion, none of what I said matters, but if you look at the reality and not the rhetoric…the estate tax is HARDLY something to be angry about, much less that repealing it needs to be some sort of urgent priority because bottom line is that it’s NOT double taxation, and it effects nearly no one…except of course the people bankrolling the GOP.