Friday, November 11, 2011

Overlooked Effect of Increasing the Estate Tax Exemption

I would like to preface this article with the observation that the Estate and Gift taxation regime does not collect much revenue.  According to the CBO (congressional budget office), 1.2% of federal revenue comes from the estate and gift taxes combined.  Furthermore, the direct revenue loss over ten years of a full repeal (assuming a $1 million exemption baseline) would be $420 Billion.  The current deficit is over $1 Trillion per year.

An article by Tax Analysts was recently posted on The Tax Prof Blog.  "Estate Tax Relief and the Erosion Of Capital Gains Tax Revenues" concerns the reduction of long term capital gains tax collection from heirs who sell their inheritances.

The authors would like to return to the Estate tax regime of 2001.  The article is used as a tax revenue argument for broadening the base of the estate tax.

Under the 2001 Estate Tax regime - there was a 1 million unified credit for gifts and estates.  This means that at death, the decedent's estate would be taxed to the extent of "Taxable Estate" - 1 Million of Exemption (reduced by taxable gifts made during their lifetime).  The remaining value of the estate would be taxed at 55%.

Heirs would receive their inheritance after the estate tax.  Section 1014 modifies the basis in inherited property to the FMV (the valuation used for the estate tax) of the property at the time of the transfer.

The current law provides for a $5 Million unified exemption.

The article points out the incentive for tax practitioners whose clients have a taxable estate below $5 Million, there is an incentive to inflate the value of property subject to capital gains treatment.  This is because they could reduce the future tax liability of heirs by increasing their cost basis in the property.

The article estimates that the inflation of the valuation of property would lead to approximately $8 Billion in lost capital gains revenue.  These projections are derived against a baseline scenario of 20% capital gains taxes, and a $1 million exemption.