Eliminating the Estate Tax is a great way to shift the tax burden from the wealthiest Americans to the middle class

The common adage against the Estate Tax goes something like this:

A person works an entire lifetime and pays income taxes on hard earned savings.  Then after the person dies, the government wants to tax the person's hard earned money again!

While that argument sounds logical and fits well into a politician's 15 second sound bite, the truth of the matter is much different.  First of all, the government allows $5,000,000 (indexed to inflation so that the amount is $5,450,000 as of this writing) to pass free of any estate tax.  Thus, for a married couple, we are talking about a $10,000,000 exemption.  Only after that exemption is worn out, the decedent's estate would owe a 40% tax on the taxable estate beyond the exemption.  So in very rough terms, a $20,000,000 estate would pay a functional estate tax of 20%.

But it's still double taxation!  Not exactly.  The overwhelming majority of people who have accumulated tens of millions of dollars in wealth, did so through investments generally subject to capital gains income taxation.  Take a real estate portfolio.  Someone could have accumulated dozens of commercial real properties over a lifetime.  And even when they sell those properties, in many cases, the property owner would make a "1031 exchange" which, in short, allows a property owner to swap real property while deferring capital gains tax liability.  This person's wealth lies primarily in their accumulation of real property.  The person can borrow against that property, enjoy the cash from the loan proceeds, and never pay one penny of income tax.  When this (more typical) wealthy person dies, she or he has paid little or no income taxation on all of that wealth accumulated.

When our hypothetical person dies, the government is essentially saying, "We have created the infrastructure for you to accumulate all of that wealth without paying any income taxes on your gain.  Now we will allow you to pass $10M+ to your descendants and we will take a 40% tax on your wealth beyond that $10M."  Here the person paid no income taxes during life and at death the estate pays an effective 20% tax on the entire estate.  Much lower than income taxes would have been!  Not only that, but the wealth grew tax-free, which is an added advantage.

Now let's revisit what really happens if our hypothetical politician eliminates the estate tax regime.  The issue is the stepped up basis of property.  With the estate tax in place, when one inherits mom's $1,000,000 stock portfolio, the cost basis for the portfolio is the date of death value of the securities.  Thus, Junior can turn around and sell the $1,000,000 in stocks with zero capital gain tax liability.  Without an estate tax, the cost basis for securities does not get that stepped up basis.  This means that if mom paid $100,000 for her $1,000,000 stock portfolio, Junior would have to pay about $180,000 capital gains taxes on the $900,000 gain.

Do you see what just happened?  The $100,000,000 estate gets a huge boon from shifting tax liability from the 40% estate tax to the 20% capital gains income tax.  And the $1,000,000 estate goes from zero capital gains taxes to $180,000 in capital gains taxes.

This is the hard sell.  Because I can't find a way to explain this in a 15 second television soundbite.  But when you read through the scenario above, you can see that an elimination of the estate tax regime is literally a shift of the tax burden from the tiny minority who has a hugely disproportionate amount of wealth to a larger plurality who has managed to accumulate some wealth.

For more on this topic, check out this article by Bill Gates, Sr.