By: Christopher Ha, JD, CFP®

Prepared on 6/14/2021.

 

This blog post gives an example of how the federal estate (death) tax would work under Senator Sanders’ estate tax proposal.

See the following Kiplinger article: https://www.kiplinger.com/retirement/estate-planning/602621/wealthy-should-act-now-to-prepare-for-bernie-sanders-estate-tax   

Estate Tax System – Introduction

            The federal estate (death) tax system is a one-time tax levied on a person’s estate when they die.

The tax system is an ADDITIONAL tax on top of the regular income tax system which taxes you every April 15th on items such as wages, social security, interest, and dividends.

The estate tax is typically paid by your executor (the person who has signing authority for your assets after you die) from your assets. As a result, the estate tax prevents your assets from flowing to the beneficiaries of your Will (e.g., your children).

Most professionally designed estate plans (e.g., Wills, Trusts) prevent estate taxes when the first spouse of a married couple dies, so estate taxes are typically owed when a single person dies.

  Estate Tax System – Illustration with June 2021 Rules

            The federal estate (death) tax is calculated based on a person’s net worth (total assets minus total liabilities) valued as of that person’s date of death.

If a person’s net worth exceeds their estate tax exemption at death, they will typically owe estate taxes.

Common exceptions:

  1. First spouse leaves everything to his spouse (the IRS lingo for this is a “Marital Deduction” for estate taxes)
  2. Spouses have set up estate tax prevention entities such as an “estate tax bypass trust” or “irrevocable life insurance trust.”

A person can “use up” their estate tax exemption during their lifetime by making gifts in excess of the annual gift tax exclusion ($15,000 in 2021) but for this blog post we will assume that is not the case.

Important numbers for estate tax example below:

  1. Net Worth at death: $12,000,000
  2. Estate Tax exemption: $11,000,000 (figure rounded for easier calculation)
  3. Estate tax rate: 40%

Say you have a client, Uncle Monopoly-Man that dies on July 1, 2021 with a net worth of $12,000,000. For this example, assume his assets are easily valued (as opposed to say, a closely held operating business, works of art, or specialty collectibles).

Uncle Monopoly-Man’s estate tax exemption at death is $11,000,000 (figure rounded down from $11,700,000 for easier calculation). For this example we assume Uncle Monopoly-Man was never married so he was unable to inherit an estate tax exemption from a spouse.

Uncle Monopoly-Man died single and for simplicity in this example assume that he cannot claim any deductions on his estate tax return, e.g., charitable gifts or attorney’s fees.

How much does Monopoly-Man’s executor need to pay IRS?

Calculation:

  1. Start with: Net worth at death: $12,000,000.
  2. Subtract: Estate tax exemption at death: $11,000,000
  3. Equals Amount Subject to estate taxes: $1,000,000
  4. Multiplied by estate tax rate of 40%
  5. Equals estate tax bill to IRS of $400,000 ($1,000,000 x 40%).

 Estate Tax System – Illustration Under Bernie Sanders Proposal

            Numbers used in the following example taken from the Kiplinger article linked at the top of this blog post. The legislation is pending so it is subject to change.

Estate tax exemption

  1. Current law: $11,700,000 per person
  2. Bernie Sanders plan: $3,500,000

Estate Tax Rate:

  1. Current law: 40%
  2. Bernie Sanders plan: see graduated rates below
    1. Base rate is 45% on taxable net worth up to $10 million
    2. Rate is 50% on taxable net worth over $10 million but under $1 billion
    3. Rate is 65% on taxable net worth over $1 billion

Monopoly Man Example Figures

  1. Net worth at death: $12,000,000
  2. Estate tax exemption at death: $3,500,000
  3. Tax Rate: graduated tax rate system starting at 45%

In this example we still assume that Uncle Monopoly-Man dies single with a net worth of $11,000,000 at death.

However, now we are going to apply the rules of the Bernie Sanders tax plan.

For reference, under the current June 2021 estate tax rules, Uncle Monopoly Man’s estate tax bill is $400,000 (recall, taxable assets of $1,000,000 multiplied by 40% estate tax rate).

Calculation under the Bernie Sanders plan:

  1. Net Worth at Death: $12,000,000
  2. Estate tax exemption at death: $3,500,000
  3. Assets subject to estate tax: $8,500,000 ($11M minus $3.5M)
  4. Estate tax rate: 45% (taxable assets are under $10M so the 45% rate applies)
  5. Equals estate tax bill to IRS: $3,825,000 ($8.5M taxable assets multiplied by estate tax rate of 45%)

 Comparison of Results

            Client Net Worth at Death                              $12,000,000

            Tax Owed Under June 2021 rules:                  $400,000

Tax Owed Under Bernie Sanders rules:          $3,825,000

Increase in Taxes:                                           $3,425,000

Increase in Taxes as a Percentage:                 850% increase in tax owed (rounded)

 Commentary on Results of Bernie Sanders Tax Plan

            The author confesses to being surprised by how much of an increase in taxes is owed under the Bernie Sanders tax plan.

Intuitively, one could reason that a change in the estate (death) tax rate from 40% to 45% should not result in a substantial change in estate taxes owed at death.

The kicker is that the total amount of assets subjected to estate taxes increased substantially despite Uncle Monopoly-Man experiencing no change in his net worth at death.

Assets subject to estate taxes at death:

Net Worth at Death:               $12,000,000

Under June 2021 rules:           $1,000,000

Under Bernie Sanders plan:    $8,500,000

  Is Such a Low Estate Tax Exemption Level “Normal?”

A “low” estate tax exemption is not without precedent.

Selected estate tax exemption levels shown below:

 Year and Estate Tax Exemption Level

Source: Instructions to IRS Form 706, Estate Tax Return

2004:   $1,500,000

2017:   $5,490,000

2018:   $11,180,000

We may see a return to the estate tax planning strategies that were required in 2004 due to a particularly low estate tax exemption: mandatory bypass trusts and irrevocable life insurance trusts effectively being required to prevent owing estate taxes at death.

As anti-government renegade Snake Plissken (Kurt Russell) might have remarked dryly in the action-adventure masterpiece, Escape from LA (1996), “the more things change, the more they stay the same.”

How Likely is the Bernie Sanders Estate Tax Plan Likely to Pass Congress?

            The author confesses to having no inside information. The author’s review of articles by commentators studied in reading the tea leaves in Washington reveals hedged bets.

Author’s pet theory: the $3.5 million estate tax exemption is an opening low-ball offer, much the same way a professional negotiator may try to influence their negotiating counter-party by “anchoring” their expectations with a particularly low opening bid.

Under current law, the estate tax exemption is scheduled to fall to $5,000,000 (prior to inflation adjustments) on January 1, 2026.

Senator Sanders’ end-game may be to retreat from his initial $3,500,000 exemption proposal and ultimately settle on accelerating the estate tax “sunset” to January 1, 2022 (instead of January 1, 2026) at a level on or around $5,000,000.

 Call to Action 1: Consider Scheduling an Estate Tax Planning Review

            Clients sensitive to estate taxes may wish to call our office at (512) 263-5400 to have a consultation with an estate planning attorney to review their exposure to future estate tax changes.

Fortunately, many estate tax strategies are revocable by clients and do not “lock in” clients to a strategy that they are unable to change if Congress goes in a different direction.

Call to Action 2: Attend Webinar to Learn How to Calculate Estate Tax Exposure for Yourself

            The author will be hosting a webinar on fundamental estate tax planning concepts with illustrated examples on Thursday, July 1st on 6:30 PM.

Time permitting, the presentation syllabus includes common estate tax planning strategies such as:

  1. Transferring estate tax exemption to spouse at death
  2. Lifetime gifts
  3. Estate tax “bypass” trusts
  4. Disclaimers

Please email us at info@tcvlaw.com if you would like to receive a webinar invitation or a copy of the slide deck for the presentation (available after July 1st).

Thank you for reading and I hope this has been helpful.