Woe be he who decides to die in NYC.  Though the reality is many people choose to move to low inheritance tax states for lifestyle purposes, why should one feel compelled to not live where they want to at the end of their lives?  Sadly, there’s one strata that once again gets crushed again by not doing so: the upper-middle class.  Originally everyone over a certain threshold could not escape the state estate-tax noose, but in recent years CPA’s have found a work around for the extremely wealthy, leaving the few who can’t access the loopholes subjected to very high marginal tax rates to make up the difference. [Read more…] about THE ESTATE TAX PT II: THE STATES TAKE THEIR POUND OF FLESH TOO. PLUS OTHER SMALL INDIGNITIES.

Just when you think you have gotten through that last hurdle and finally vaulted your genes out of the upper middle class and into the truly wealthy, they crush you with estate taxes.  Though this tirade is really for the upper part of the upper middle class, the targeting of this particular segment, above one economic threshold but below the higher ones, is the same injustice that all my previous ones were.  In fact it could be my number one “crushing” if I had to rate them in terms of egregiousness.

Before I get started and lay out the numbers, let me just state for the record that I am all for an estate tax1, just not one that overwhelmingly inflicts its greatest pain on the upper-middle class …once again.

Ok, let’s lay out the thresholds and define the “targeted” segment.  At the federal level, a 40 percent tax is levied at death on estates of more than $5.25 million for an individual or $10.5 million for a couple2.  That cuts out everyone below this level.  Pretty straightforward and simple, and seemingly very generous in terms of eliminating most people from the estate tax and focusing solely on the affluent.

The higher threshold, or where that 40% rate starts to get rolled back, is much tougher to define.  As a general guesstimate, I would say somewhere between fifty and hundred million.  Before I get to “why” it disappears, let’s put a face to the number in the middle of this death blow.  Joe is a cardiologist/partner in a law firm/small businessman making $500,000/750,000/1,000,000 a year.  From this he prudently saves $50,000/100,000/200,000 a year for 35 years of working and averages an 8% annual return over that period. Thanks to the power of compounding he will have $14/28/56 million in the bank when he retires.

Sounds like a nice stash right?  It is, and deservedly so considering the long hours he worked and lifestyle sacrifices he made.  Hopefully he’ll have a lengthy retirement to enjoy and spend it, at the end of which the federal government will take the aforementioned 40% of everything over $10.5 million3.  So be it.

At some level though, it doesn’t have to be.  That’s because tax accountants and lawyers have created, or lobbyists have lobbied for, and/or congressmen have legislated, special exemptions and vehicles that only make economic sense if you are extremely wealthy.  Given acronyms such as CLAT’s and GRAT’s, or Jackie O. Trusts or just plain “holding companies,” those that can avail themselves of the structures can greatly bypass the 40% rate altogether.  I won’t get into the details of “how” they do this, but it’s pretty easily explained in the articles I link to below, a quote from which I will tease you with as it summarizes the higher threshold:

“I hate to say it, but the very rich pay very little in gift and estate tax,” said Jerome Hesch, a lawyer at Berger Singerman LLP in Miami who reviewed some of the Walton family’s trust filings for Bloomberg. “At the Waltons’ numbers, the savings are unbelievable.”

More relevant to this story, is that they are very expensive to set up and somewhat costly to maintain, let’s say $1 million in cash up front and $100,000 a year going forward.  Not a bad price to pay if you’re stashing a billion or two, …or even a 1/2 or a 1/4, but for Mr. 14/28/56 it’s almost the same price, and is a big chunk of the overall percentage.  Moreover, these vehicles require one to lock up their money for decades.  That’s easier to do if we’re talking billions and hundreds of millions, less so for Dr. 14/28/56.

“So,” you say once again “the inheritance tax is just the right one pays to live your life in this country.”  No argument.  But as outlined below, the wealthiest get to bypass it, and if you believe that the collection of taxes are a zero-sum game, than the shortfall has to come from those who do pay it -> you!  Without these uber-wealthy tax avoidance schemes, maybe the overall rate could be lowered to 20% for everyone over $10.5 million?

No, that would be too fair, so once again the upper-middle class takes the hit.

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How Wal-Mart’s Waltons Maintain Their Billionaire Fortunes – “America’s richest family, worth more than $100 billion, has exploited a variety of legal loopholes to avoid the estate tax, according to court records and Internal Revenue Service filings”  Ok, so we’ve figured out the very highest recipient, but how low does the high threshold go?  Beats me!

Accidental Tax Break Saves Wealthiest Americans $100 Billion – “These tax shelters may have cost the federal government more than $100 billion since 2000, says Richard Covey, the lawyer who pioneered the maneuver. That’s equivalent to about one-third of all estate and gift taxes the U.S. has collected since then.”  If the wealthiest Americans saved $100 billion, who made up the difference?  That one I know – the next wealthiest!

1. Without going into great, unenlightening detail as to why, I’m just in the camp that sees tax collection overall as a zero-sum game, and doesn’t buy the argument that the estate tax alone is “double taxation.”  Everything is double/triple taxation, get over it [↩]
2. for the purposes of this argument I am not including estate taxes assessed by the 50 states right now, but will touch upon it further down [↩]
3. assume he’s married …these guys always are [↩]

For all it’s bad raps, I think pretty highly of Social Security.  While a lot of people like to focus on its future insolvency and occasionally refer to it as a Ponzi scheme, I think the original idea behind it and the structure, were pretty solid.  Furthermore, I think a few small fixes is all it would take for it to remain solvent.

But even if one is a member of the small-government, libertarian, or conservative camps, my experience observing finance and human nature, is that many people do not set aside money for retirement.(period!)   Thus if you do not force people to save and put it into a locked box, they will come back and ask for a do-over 30 years hence.  And if enough do so (i.e. vote), they will get it.  At which point those that have been profligate will squeeze the most out of the system, by taking it from those who were not.

Here are a few facts buttressing my viewpoints regarding the need for maintaining Social Security from an excellent 2005 article by Roger Lowenstein in The New York Times:

The average stipend for a 65-year-old retiring today is $1,184 a month, or about $14,000 a year …for two-thirds of the elderly, Social Security supplies the majority of day-to-day income. For the poorest 20 percent, about seven million, Social Security is all they have. Even those figures understate the program’s importance. According to an agency publication, ”Income of the Population 55 or Older: 2000,” 8 percent of elderly beneficiaries were poor, but a startling 48 percent would have been below the poverty line had they not been receiving Social Security.

Yet whether I like it or not, Social Security is yet another shiv to the upper-middle class.  It may be the one we have to take for the team, but if so [Read more…] about SOCIAL SECURITY & PENSIONS