8 Inheritance Tax Pros and Cons

It’s been said that the person with the most toys still dies. What happens to those toys, which really is the wealth they’ve accumulated over the years, is the subject to great debate. An inheritance tax, sometimes referred to as an estate tax, may apply to that accumulated amount so that the government can still get a piece of the action even after your family has held a wonderful service in your honor.

In the US, the inheritance tax is a flat 40% on taxable estates that are above the $5 million exemption level that was indexed for inflation in 2011. Here are the pros and cons of this policy to consider.

The Pros of the Inheritance Tax

1. It reduces the levels of income inequality.
The haves are getting more than the have nots right now in the eyes of many, but this tax helps to equalize the playing field. By removing the high levels of wealth from estates while still preserving a majority of the dollars above the exemption amount, more than $200 billion comes into US coffers to provide funding for security, infrastructure, social programs, and other needs that benefit everyone.

2. It increases charitable donations.
Because of the inheritance tax, many in the wealthy class donate funds to charitable causes as a way to reduce their overall net worth. This helps to reduce their tax liabilities after death, but it funds the social programs that the world needs right now. Imagine what would have happened if men like Henry Ford or Andrew Carnegie had kept their wealth instead of funding philanthropic efforts.

3. It still rewards success.
With the average income in the US just above $50k per year, that’s literally just 1% of what the exemption is for this tax. In practical terms, an estate worth $10 million would have a potential tax liability of $2 million because of the extra $5 million above the exemption level. This means success is still rewarded, even if the tax levels are relatively high on this amount, because the estate still has plenty of value to hand down to its heirs.

4. Special rules apply to certain industries.
Because of the structure of this tax, most small businesses are automatically exempt from needing to pay it. Certain farms and other family businesses, however, may exceed this $5 million level simply through real estate assets even if there is minimal cash flow. To prevent an unnecessary burden to heirs, there are certain special rules in place for certain businesses, especially farms, to prevent the tax from applying.

The Cons of the Inheritance Tax

1. Some see it as form of income redistribution.
The American Dream has always been about pulling yourself up by your bootstraps to make the best life possible for yourself. When you die, those successes shouldn’t die with you, yet that’s essentially what the inheritance tax does in the eyes of some. The government is pulling out a large chunk of the cash you earned for your family to distribute it to others who haven’t experienced the same levels of success.

2. It is costly to get a proper evaluation of assets.
Although it raises billions ever year, the inheritance tax is less than 1% of the overall revenues that are brought in every year. The costs of bringing in this cash is also the highest per capita when compared to any other tax revenues. This is because the government incurs large levels of expense in the valuation and collection of the revenues it deems is owed.

3. It can force families to sell their businesses.
Although the laws are designed to prevent as many small businesses from being burdened by this tax as possible, there are always a few that fall through the cracks every year. About two dozen businesses wind up being sold for their assets simply because the government requires this tax to be paid. That forces an uncomfortable question: would the tax revenues generated by the business if it were allowed to survive be greater in the long term than the short term gains from the inheritance tax?

4. It reduces available capital.
Even if a business is able to survive the inheritance tax, the amount that is owed will severely limit the amount of liquid cash the heirs will have available. This could force a potential bankruptcy or drive the company out of business over time because of the tax liabilities. In some cases, it could even be said that some of the income being taxed has already been taxed through other methods, creating a situation that is only beneficial to the government.

Some people love the idea of the inheritance tax. Others think it is time for it to be repealed once and for all. The pros and cons of this tax show that each benefit has a disadvantage which balances it out. How do you feel about the inheritance tax? Would you like to see it repealed? Or do you believe it is an important source of revenue?