Policy Basics: The Estate Tax

WASHINGTON, Aug. 14 -- The Center on Budget & Policy Priorities issued the following news release:

A long-standing part of the tax system, the estate tax is a tax on property (cash, real estate, stock, or other assets) transferred from deceased persons to their heirs. In addition to the federal estate tax, taxes on inherited wealth are also a traditional and common revenue source for states.

The federal estate tax is levied only on the portion of an estate's value that exceeds the exemption level, minus deductions, such as for charitable giving. Largely because of its generous exemption levels, only the wealthiest 0.2 percent of estates pay any estate tax, and typically at fairly moderate rates. The tax also affects very few small farms and businesses.

The estate tax also serves as a backstop to the capital gains tax: without it, the increase in the value of unsold assets that had appreciated over time would never be subject to taxation.

Estate Tax Has Weakened Considerably Since 2001

Legislation enacted in 2001 gradually phased out the estate tax by raising the exemption level and reducing the rate, leading to the tax's temporary repeal in 2010. The tax was scheduled to return in 2011 under pre-2001 rules (an individual exemption of $1 million and a top rate of 55 percent), but policymakers instead permanently extended it in much weaker form.

Under current law, the exemption level is $5.49 million per person for 2017, indexed for inflation, and the top statutory rate is 40 percent (see table). Roughly 2 of 1,000 estates will have to pay any estate tax this year, according to the Joint Committee on Taxation.

Estate Tax Rate Is Modest

Taxable estates will owe 17 percent of their value in tax in 2017, on average (see chart). This "effective rate" is much less than the top marginal rate of 40 percent for three reasons:

* The tax applies only to the value of the estate that exceeds the exemption level. For example, at the current exemption level, an estate worth $6 million would owe taxes on at most $510,000, for a maximum effective tax rate of less than 4 percent.

* The tax contains a number of provisions that reduce estates' tax liability, many of them originally designed to protect farmers and small businesses.

* Many wealthy estates use complex estate planning methods to exploit loopholes that reduce their tax liability and allow them to pass on significant portions of their estates tax-free.

Estate Tax Affects Very Few Small Farms and Businesses

Some worry that the estate tax could threaten family-owned small farms and businesses. However, in 2017, only roughly 50 small farm and business estates will owe any estate tax, Tax Policy Center (TPC) analysis finds (see chart). Furthermore, TPC estimates those few estates will owe less than 6 percent of their value in tax, on average. Most will have sufficient liquid assets to pay the tax without having to touch the farm or business. In addition, special estate tax provisions allow the few taxable estates that may have any issues paying the tax immediately to pay spread payments over a 15-year period (at low interest rates).

Estate Tax Serves as a Backstop to Capital Gains Tax

Usually, capital gains are taxed when the asset is sold or disposed of and the gain is "realized." But if a person holds an asset that grows in value until his or her death, that "unrealized" capital gain is forgiven, and neither the heir of the estate nor the deceased person is taxed on it. These unrealized capital gains account for a significant proportion of the assets held by large estates -- ranging from 32 percent for estates worth between $5 million and $10 million to as much as about 55 percent of the value of estates worth more than $100 million (see chart). Thus, without the estate tax, a large portion of these estates would never be taxed.

Estate Tax Is Economically Sound

Opponents of the estate tax argue that the tax hurts the economy. However, evidence shows the estate tax likely has little or no impact on overall private savings. But the estate tax has a positive impact on overall national (private plus public) saving because of the revenues it raises -- the tax will generate about $280 billion over 2018-2027 under current law, according to the Congressional Budget Office. Research also finds that the estate tax encourages heirs to work.

Thus, the estate tax is an economically efficient way to raise revenue that supports public services and lowers deficits without imposing burdens on low- and moderate-income Americans. It plays an important role in our revenue system, particularly given our long-term budget challenges.

See details here (https://www.cbpp.org/research/federal-tax/policy-basics-the-estate-tax)