By Edward Zelinsky
In the American Taxpayer Relief Act of 2012, Congress and President Obama recently agreed that the federal estate tax will be imposed at a 40% rate on estates over $5,000,000. On 11 December 2012, a group of affluent Americans, organized under the banner of Responsible Wealth, had called for a stronger federal estate tax. In particular, Responsible Wealth urged that federal estate taxation begin at a rate of 45% on estates over $4,000,000.
Neither the American Taxpayer Relief Act nor the Responsible Wealth statement addressed a particularly egregious loophole of federal transfer taxation, namely, the grandfather exemption of the generation skipping tax (GST). Under this exemption, the GST does not apply to trusts established before 25 September 1985. By virtue of this GST exemption, older wealth is immunized from federal transfer taxation while otherwise equivalent new wealth is taxed under the estate tax.
Because Responsible Wealth includes heirs to older fortunes, such as Dr. Richard Rockefeller and Dr. Abigail Disney, Responsible Wealth is uniquely positioned to address this unfairness of the federal tax statute. As part of its self-proclaimed mission to strengthen the federal estate tax, Responsible Wealth should lead the effort to repeal the GST grandfather exemption and thereby subject old wealth to the same transfer taxation as new wealth.
While the details are complex, the basic story is not. It was once both easy and common for wealthy individuals to bestow fortunes on their children, grandchildren, and perhaps even their great-grandchildren free of any further federal estate taxes. This multi-generational tax immunity was achieved through so-called generation-skipping trusts. Such trusts distribute income and principal to the offspring of wealthy individuals without that lucky offspring ever paying any further estate taxation.
The moniker “generation-skipping” is misleading. Under such trusts, the benefits of wealth don’t skip any generation. Just the estate taxation of wealth skips generations as the estates of individuals dying after the founder of the family fortune pay no further federal estate taxes.
Consider, for example, Dr. Disney’s family. Her fortune stems from her grandfather, Roy O. Disney. Mr. Disney, along with his brother Walt, created an entertainment behemoth including valuable icons of American culture. It is likely that, when he died in 1971, a man as wealthy and well-advised as Roy O. Disney left his fortune to his family in a generation-skipping trust. (His brother Walt did.) If so, in 2009, when Roy O. Disney’s son Roy E. Disney died, no estate tax was levied on his death. That trust (assuming the common practice) now continues for Dr. Disney, the granddaughter of Roy O. and the daughter of Roy E. It is likely that, when the generation-skipping Disney trust passes to Dr. Disney’s heirs, they too will owe no further estate taxes.
In 1986, Congress decided that this kind of multi-generational estate tax avoidance is unacceptable. Accordingly, Congress supplemented the federal estate tax with the GST to block these kind of tax-avoidance arrangements. The GST is a variant of the estate tax and removes the tax advantages of generation-skipping trusts. Together, the estate tax, now supplemented by the GST, requires wealthy families to pay federal tax at least once every generation — unless a generation-skipping trust was created before 25 September 1985.
In those cases of older wealth, neither the federal estate tax nor the new GST applies. Thus, any generation-skipping trust created by Roy O. Disney before his death enjoys continuing federal tax immunity well into the 21st century by virtue of the GST grandfather exemption for trusts in existence on 25 September 1985.
Whatever the policy merits or political need for the GST grandfather exemption in 1986, it has outlived its usefulness. If new, i.e., post-1985, wealth is to be subject to estate taxation once every generation along the lines recently adopted by Congress and advocated by Responsible Wealth, older wealth should be subject to such taxation also. The members of Responsible Wealth who benefit from the GST grandfather exemption are uniquely positioned to call for the abolition of the exemption from which they and their families unfairly benefit. They should do so.
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. His monthly column appears here.