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Monday, October 31, 2005


Inherence Tax

The life cycle of a human: Birth – Death. What is the dash? The dash represents the person’s life. A person could do so many things with that dash, but what happens to the wealth accumulated after the person dies? The wealth and assets are to be transferred to the individual’s heirs. Yet, before the heirs get any money, property, or assets everything is valued by the Internal Revenue Service and taxed. Many people have a problem with the inheritance tax and feel that it is not only an unfair double tax but feel that their life’s wealth should be passed on free of taxes. The inheritance tax can put small businesses into bankruptcy and hurt families who invest all their wealth into land, such as farmers. Not only is the government hurting the economy, but in some cases the government is collecting less then they could be.
Imagine that you owned a small auto shop and you died. All your money and assets were tied up in the shop and your two boys who worked the shop with you inherit your business. Before your boys could do anything the Internal Revenue Service comes and values your business at 5 million. Now your boys have to pay taxes on that 5 million. Yet, they have no cash to pay the taxes so they have to sell the business to Pep Boys. In a best case scenario say that Pep Boys pay 5 million for the company. Now your children can pay off the inheritance tax and your income tax with some money left over. The money that is left over is substantially less then what you wanted to leave them and they are out of a job. Not only that but, all the employees that use to work at the shop are now unemployed and Pep Boys is the only store within miles to offer auto supplies and services. Pep Boys can now mark up their prices.
In response to society’s actions because of inherence taxes an act was passed. In 2001 George Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001. This law states that the federal estate tax exemption increased to $1 million in 2002 and will continue to gradually increase to $3.5 million in 2009. Then in 2010, the federal estate tax ends and in 2011 the federal estate tax is resurrected to the rates that occurred in 2001. Not only that but the top federal estate tax rate decreased in 2002 to 50% and will continue to decrease to 45% in 2009. In 2010 there will be no federal estate tax rate. Then the top federal estate tax rate will be revived to 55% in the year 2011. Lastly, in 2010, a "carryover basis" rule will apply, which will tax heirs on the capital gains they inherit. As it stands now, heirs who decide to sell an asset don’t have to pay any taxes period. However, in 2010, heirs who sell an asset will have to pay an income tax on the asset if the asset is sold for more than it was bought for.
The Economic Growth and Tax Relief Reconciliation Act of 2001 is the first step in eliminating the tax. Yet, one thing should be changed in the act: the old tax rates should not be revived in 2011.
It hurts the economy when small farmers and businesses are forced into sale or bankruptcy. The bigger corporations have less competition and more free rein to do what they want to do. What the government should do is phase out the inherence tax all together forever. By doing this people can inherent small businesses without having to sell their business just to pay the taxes on it. If the business is allowed to continue, it will still be producing payroll taxes and income taxes. The people who are employed at the company will be paying their taxes and will not be unemployed. In the end these taxes the business generates will be more taxes collected then the inherence tax would have collected. This fact has been proved over and over by our own system of government. When we lower taxes either on a state or national level we increase the economic expansion of our nation, spurring a larger tax base to collect on, and increasing the revenues the government has available to operate. When we increase taxes, we slow economic activity, lower the base of revenues we can collect, and fall into a downward spiral which usually causes economic depressions.

Michele offers a nice description off how the economic incenties in the inheritance tax affect individual choices, individual lives, and individual well-being. Notice that these effects are post-death. There are also incentives to consider pre-death. How are the incentives changed for individual economic choices when government taxes wealth at death?
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I think that people who are going to leave their wealth will over invest it into human capital, such as their children’s education. I know two parents that have bought both children their own houses, so that the money is used and invested now. That way they don't have to deal with too much in inheritance tax. Another thing people could do is to take their money and gift it over a certain period of time, thus getting out of some inheritance taxes; as long as they gift $12,000 or under.
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