Understanding Estate Taxes: Why They Exist and Why They Are High

There is often a misconception about inheritance taxes in the United States. Many think that the term "inheritance tax" refers to a federal tax, but in reality, there is no such thing. In fact, inheritance tax is a type of estate tax and is only levied by a few state governments. Understanding estate taxes is crucial to comprehend the nuances of wealth transfer in the United States.

Why are Estate Taxes High?

Despite the misconception, the United States does not have a federal inheritance tax. However, the estate tax, a different form of taxation, applies only to estates over a certain value. The current threshold is roughly $12 million for an individual estate or $24 million for a married couple. As of 2020, only 6 states have an estate tax, and it affects a tiny fraction of deaths in the country.

While the number of estates subject to estate tax is small, the rationale behind these high taxes is clear. The estate tax aims to prevent the perpetuation of wealth without any tax implications. This is where the concept of adjusted cost basis comes into play. When assets are sold, their capital gains can be zeroed out upon the death of the owner, meaning the new owner would not have to pay taxes on the appreciation. This can be advantageous, particularly for businesses or farms.

However, for large estates accumulated largely through capital gains, it would be unfair if all that money passed on without paying taxes. Estate taxes are designed to capture any potential un-taxed capital gains that would otherwise go untaxed. This ensures that, even for those with substantial fortunes, some amount of tax is paid during the transfer of wealth.

The Controversy: Perspectives on Estate Taxes

The debate surrounding estate taxes is multifaceted. On one hand, there are those who argue that estate taxes are necessary to prevent individuals from accumulating so much wealth that it skews the economic playing field. Critics of these taxes often cite examples such as the Rockefellers or Amazon, suggesting that without inheritance taxes, family wealth would continue for generations. Supporting government and welfare programs, these individuals believe that taxing inheritances can benefit broader society.

On the other hand, there are those who see estate taxes as a form of punishment or even as an injustice. Many argue that families who have worked for their wealth over generations should not be unfairly taxed. Consider the story of a farmer who’s ancestors homesteaded land, invested in capital improvements, and passed down the business through multiple generations. These generations not only worked the land but also raised families and took various risks to maintain the farm. Taxing their inheritance could be seen as taking a hard-earned legacy away.

Conclusion

Estate taxes, while not as widely discussed as other forms of taxation, play a significant role in shaping wealth distribution in the United States. Understanding the nuances of estate taxes is crucial for any discussion on inheritance and wealth transfer. Whether one views these taxes as a necessity for fairness or as an unnecessary burden, the existence and impact of estate taxes on wealth inequality are undeniable.