Federal Estate Tax: What is It, and Why Do We Have It?

Federal Estate Tax: What is It, and Why Do We Have It?

For many people, the word estate can conjure rarified visions of mansions set amidst expansive lawns in exclusive communities, and when it comes to federal estate tax, those visions maybe somewhat accurate.

The federal estate tax  – tax levied on property bequeathed to heirs – does not affect 99% of Americans since only about 1% of Americans are even wealthy enough to be affected by it.

Just how wealthy, you wonder? As of 2018, unless an estate’s value exceeds the exemption figure of $11.18 million per person (that’s $22.36 million per couple), it isn’t subject to federal estate taxes.

The thinking is that those enjoying the benefits of extreme wealth should shoulder a greater tax burden in contributing to the federal government’s job to “promote the general welfare” as articulated in the preamble to the U.S. Constitution. The primary opposing argument to the estate tax is that the cash and assets included in most estates has already been taxed at least once.

There are some who have found legal loopholes in the estate tax law that allow them to avoid what could otherwise be many millions of dollars in federal estate tax. These loopholes are often characterized by experts as a “heads I win, tails we tie,” proposition. Grantor retained annuity trusts (GRATs), for example, work on this principle and are favorite tax shelters for wealthy estates. This particular loophole protects wealthy estates from paying taxes on stocks or other high-end assets that rapidly skyrocket in value. It has been estimated by the lawyer known for discovering the GRAT loophole that this system has let the wealthiest estates off the hook for as much a $100 billion in taxes in the last 17 years.

Estates subject to the estate tax, generally pay about one-sixth of their value in tax. According to the Center on Budget and Policy Priorities (CBPP).

As explained by Chye-Ching Huang, Deputy Director of Federal Tax Policy, on the CBPP’s website:

“The effective rate is so much lower than the top rate for several reasons.  First, estate taxes are due only on the portion of an estate’s value that exceeds the exemption level; at the 2017 exemption level of $5.49 million, a $6 million estate would owe estate taxes on $510,000 at most. Second, heirs can often shield a large portion of an estate’s remaining value from taxation through generous deductions and other discounts that policymakers have enacted over time.”

Only a tiny fraction of the American population will ever have to concern themselves with federal estate tax. For those who do, the Tax Cuts and Jobs Act of 2017 has doubled the exempted estate value.

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