By Edward Zelinsky
In light of the Democratic party’s control of both houses of Congress and the White House, it is probable that the federal government will continue to levy an estate tax when affluent decedents transmit their wealth to their descendants. The most likely possibility is that Congress will continue to exempt decedents’ estates valued less than $3.5 million while it taxes estates exceeding that threshold amount. In light of President Obama’s statements on the subject, it is also probable that such excess will taxed at a 45% rate when a decedent dies and leaves his wealth to his descendants.
Important details remain to be determined, e.g., whether the $3.5 million federal estate tax exemption will be adjusted annually for increases in the cost of living; whether various estate tax planning techniques such as family partnerships will be curbed or eliminated.
How ever these matters are ultimately resolved, the legislation perpetuating the federal estate tax should contain a provision subjecting to federal taxation all large intergenerational transfers of family wealth. Specifically, Congress should repeal the grandfather exemption from the federal generation skipping tax (GST) for irrevocable trusts established on or before September 25, 1985. This exemption unfairly immunizes from federal taxation transfers at death of “old” wealth while economically equivalent transfers of new wealth are taxed.
As an historic matter, the federal estate tax was often avoided through the use of so-called generation skipping trusts. When a decedent established such a trust, the trust continued for his children, grandchildren and great-grandchildren with no further federal estate taxation being due whenever any of these lineal descendants themselves subsequently died.
The term “generation skipping trust” was a misnomer. The trust didn’t skip any generations. The tax did. Families could continue to enjoy and grow inherited wealth in trust without paying federal estate taxes.
In 1986, Congress prospectively outlawed this planning technique by imposing the federal GST. The GST backstops the federal estate tax by assessing a tax on a death-related transfer of wealth in trust whenever an equivalent transfer outside of a trust would trigger the estate tax. Thus, with the GST in place, families can no longer use trusts to avoid taxation on intergenerational transmissions of large fortunes. Rather, federal taxation must be paid at least once in every generation.
However, Congress grandfathered from the GST transfers of wealth from trusts which were in existence and irrevocable on September 25, 1985.
This exemption creates for federal tax purposes an unfair and unconvincing distinction between new wealth (think Michael Bloomberg) and old wealth (think the Kennedys and the Rockefellers). Because of the federal GST, families inheriting new wealth now pay a federal estate tax or its equivalent at least once every generation. However, families inheriting old wealth live estate-tax free by virtue of the grandfathered status of tax-avoiding trusts established by such families’ patriarchs and matriarchs on or before September 25, 1985.
There are respectable arguments for and against federal estate taxation. However, if there is to be an estate tax, there is no convincing reason to treat differently old wealth from new wealth.
If, as the President Obama and the current Congress apparently believe, federal estate taxation represents sound social and tax policy, there is no warrant for continuing to exempt from such taxation some families simply because they had the good luck to make their fortunes before 1985. As part of its legislation continuing the federal estate tax, Congress and the President should eliminate the immunity from generation skipping taxation for intergenerational wealth transfers accomplished by irrevocable trusts established on or before September 25, 1985. For federal tax purposes, all inherited wealth should be taxed the same, whether it is “old” wealth or “new” wealth. The GST grandfather exemption should be abolished.
Edward A. Zelinsky is the Morris and Annie Trachman Professor of Law at the Benjamin N. Cardozo School of Law of Yeshiva University. He is the author of The Origins of the Ownership Society: How The Defined Contribution Paradigm Changed America.