Future of the Federal Estate Tax

In NY Times op-ed, Ray D. Madoff lambasts dynasty trusts: “America Builds an Aristocracy”

On July 9, 2010, the New York Times published America Builds an Aristocracy (free registration now required), by Ray D. Madoff.  Madoff begins by describing dynasty trusts as an estate planning technique:

These estate-planning instruments enable affluent people to provide their heirs with money and property largely free from taxes and immune to the claims of creditors. And rather than benefit only children and grandchildren, dynasty trusts provide for generations in perpetuity — truly creating an American aristocracy. . . .

This type of trust is new because until very recently most states had a “rule against perpetuities,” which limited the term of any family trust to about 90 years, after which time the family members would own the property outright. This rule derived from the idea that property is best controlled by the living.

In the mid-1990s, however, many states repealed the perpetuities rule, and now any wealthy American can set property aside for his heirs forever, simply by hiring a trustee from one of these states.

Madoff closes her op-ed article with a proposal on how the federal government can limit dynasty trusts:

What can be done to eliminate these trusts? A state-level solution is unlikely, since all 50 states would need to act in unison. But Congress could fix the problem by limiting the generation-skipping-transfer exemption to trusts that last no longer than two generations. After that, beneficiaries of a trust should be subject to tax, like everyone else. Then America would not have to face the uncontrollable growth of a new aristocracy.

Commenting on Madoff’s op-ed, Martin Shenkman (estate planning attorney, New Jersey) had the following advice in Taxpayers Keep Fiddling While Tax Bennies are Burning (LawEasy.com, 7/12/10):

Dynasty Trusts: Really rich folk like to transfer assets to perpetual trusts in Delaware, Nevada, South Dakota or Alaska, among other states. These trusts can grow forever outside the estate, gift and GST tax regimes. They may also facilitate minimizing state income tax. Assets can remain out of the reach of creditors. A university profess[or] wrote an article in the July 12, 2010 New York Times lambasting these trusts as contributing unreasonably to the concentration of wealth in our country. Well, if you have big buckaroos and have done a dynasty trust (or two….) move now.

(Special thanks to Michael Hepner, a benefits professional, for alerting me to the comment by Shenkman.)

Ray D. Madoff argues for having the federal estate tax

On July 6, 2010, the Los Angeles Times published an op-ed by Ray D. Madoff (professor at Boston College Law School, author), Inherited wealth shouldn't get a free pass on taxes.  Madoff makes the following points against repealing the federal estate tax:

• The wealthy would receive a windfall.
• Congress would lose revenue.
• "[F]ailing to tax large inheritances promotes concentrations of wealth that harm our democracy."

Previously, I wrote about another op-ed by Madoff:

• Ray D. Madoff's opinion on fixing the federal estate tax: an unbalanced proposal (11/21/09)
• Readers respond to Ray D. Madoff's recent New York Times op-ed proposal(11/29/09)

Readers respond to Ray D. Madoff's recent New York Times op-ed proposal

Last Saturday (11/21/09), Ray D. Madoff published published a New York Times Op-Ed article, Protect the Farm, Tax the Manor.  (See my earlier post for a summary and a review.)

Today (11/29/2009) the New York Times published four letters to the editor in which readers give their opinion on Madoff's proposal -- My Estate Tax, Your Family Business. 

The first letter, by Robert Miller, highlights what he views as socialist overtones in Madoff's proposal.  Miller thinks that Madoff's plan "echoes" Karl Marx.  He also thinks that Madoff's plan discriminates against the estates of wage earners.  He concludes by writing, "I earned that money and paid my taxes on it. It is mine and I want to give it to my hard-working kids, not to the government." 

The second letter is by Melissa P. Walker, a trusts and estates lawyer in Atlanta.  Walker would keep the exemption amount and rate as they currently are, and she would not give farmers and small business owners the special treatment that Madoff proposes.  Walker believes that such provisions are already in the tax Code.  She also believes that Madoff discriminates against "estates built through savings and investments."

The third, and longest, letter is by Steven Baker, a CPA in Florida.  Baker strongly feels that farmers and small businesses already get special treatment.  He writes, "After practicing estate planning for more than a decade, I can attest that I have yet to see a family farm or small business go under because of the estate tax."

I have heard Baker's statement repeated many times by many practitioners.  You might be interested to read a direct response to this attestation.  See my November 3, 2009 interview with Josh Rolph, a national affairs director for the California Farm Bureau Federation.

The fourth letter is written by Michael Hepner, a benefits professional, and yours truly.  We argue that Madoff creates a "a false dichotomy between good and bad wealth."  For more on my other projects with Michael, see here. 

New York Times published a letter co-written by Michael Hepner and yours truly

I am pleased to let you know that on Sunday, November, 29, 2009, the New York Times published a letter to the editor co-written by Michael Hepner, MBA, a benefits professional, and yours truly.  The letter responds to Ray D. Madoff's recent New York Times op-ed article, Protect the Farm, Tax the Manor.

Michael and I were discussing my summary and review of Madoff's proposal.  We developed on the ideas in the review and decided to share our richer analysis with a wider audience.

Michael and I are currently co-writing a book on celebrities and personal finance for the public.  We will be looking for a publisher soon.  We hope to explain complex tax laws and personal finance issues to the general public through a number of projects.  If you have an interest, please comment to this post or contact me. 

Ray D. Madoff's opinion on fixing the federal estate tax: an unbalanced proposal

On November 21, 2009, Ray D. Madoff (professor, Boston College Law School) published a New York Times Op-Ed article, Protect the Farm, Tax the Manor. 

This article is interesting because Madoff proposes a solution for estate tax reform.  It is important because Madoff is highly respected and is well known among practitioners because she is the lead author of Practical Guide to Estate Planning (CCH).

Madoff opposes President Obama's proposal, which would make permanent the applicable exclusion amount of $3.5M and tax rate of 45%, for two reasons:

1. It would provide the government less revenue than under current law (which repeals the estate in 2010 and has it come back with a vengeance in 2011).
2. It would harm farmers and small businesses and constitute "an unnecessary giveaway to Americans who least need it."

Madoff's proposal would first "protect the farm" by providing a separate exclusion amount for farmers and small business owners:

Congress and the president should forge a different compromise that would respond to the concern for the family farmer and business owner, but still impose appropriate taxes on the wealthy heiresses — and heirs — of America. . . .

It is important to us that children be able, if they so desire, to carry on the work of their parents. Thus, it is appropriate for the estate tax to have a large exemption for family businesses — perhaps as much as $10 million, and indexed to rise with inflation.

Madoff would then tax everyone else at a higher rate and provide them with a lower exemption:

American estate tax rates have been as high as 77 percent, so 55 percent would be reasonable when coupled with a general exemption of $1 million to $2 million.

Review:

On one hand, Madoff's proposal comes off as balanced.  She would lower the estate tax for its most vocal opponents -- farmers, ranchers, and small business owners -- but she would raise the tax for others, including those with "manors." 

On the other hand, imposing a higher estate tax on everyone other than farmers and small business owners leans to the left. 

• Madoff makes sure to mention $1M as a possible general exemption amount.  But this lower amount would catch far too many people.   
• It is important to note that she also cites the very high historic rate of 77%.  This reference serves an important psychological purpose.  It makes a 55% tax rate seem small in comparison.  The effect would be far different if we started with absolutely no estate tax, which also was the case at one time, and then jumped up to 55%. 

These numbers -- $1M and 77% -- are not innocuous.  Daniel Kahneman, a Nobel laureate, has shown that "[i]t matters a great deal what the starting point (the reference point) is." (From a short article about his work.) 

Madoff's tilt to the left is also shown in the following cleverly written paragraph:

There is a big difference between wealth acquired through hard work and creativity and wealth bestowed as an accident of birth, and Congress should not be afraid to make this distinction. Keep in mind that inherited wealth is completely free of income taxes. Thus, while a person who earns $200,000 by working must contribute more than $50,000 in federal taxes, a person who inherits $200,000, or even $200 million, pays no income taxes at all.

The first sentence is clearly true: there is a difference between money that is earned by a person and money that is given to a person.  But the rest of the paragraph is misleading for the following reasons:  

1. Inherited wealth is not free of income taxes.  Earned income has already been subject to income taxes.  Built-in gains on property, on the other hand, has not been subject to tax.
2. The federal estate tax is a second tax on money that is from earned income.  The first tax is the income tax.  The second is the estate tax, which is a tax imposed on the privilege of transferring money at death.

Overall, I find Madoff's proposal to protect farmers and small business owners appealing, but I am uncomfortable with her treatment of everyone else.

(Please note that I could not give Madoff's proposal the balanced scale icon.  Instead, I gave each part of her proposal a different icon because each has a different lean.)

[Updated for clarification on 11/21/09 at 8:00 pm]