Congress is close to permanently repealing the federal estate tax this year, freeing thousands of family-owned contractors and dealers from the burden of planning how to pay (or evade) this “death tax.”
The U.S. construction industry has made a very strong case to legislators that the tax discourages economic growth as firms sink their money into insurance, accounting approaches and other methods of planning for the death levy, which can take approximately 50 percent of an estate.
It argues, too, that the tax is levied on money that has already been taxed, and that, when someone dies, it shouldn’t be a taxable event.
The U.S. House of Representatives voted on April 13, by a vote of 272 to 162, to permanently repeal the tax. Observers told Construction Equipment Guide (CEG) that at least 58 U.S. senators now also favor repeal, and that there’s a good chance that the Senate also will pass the measure, with the required minimum of 60 votes, early this summer.
Uncertainty Under Present Law
The Bush Administration’s 2001 tax relief law gradually increases the “unified credit exemption,” which is the amount an individual can pass on to heirs without paying estate taxes on it, from $1.5 million in 2005 to $3.5 million in 2009. The exemption doubles for husband and wife.
The tax is levied on all assets above the exemption amount, including home, car, investment, and 401K retirement funds. Rates gradually decrease from 47 percent in 2005 to 45 percent in 2007, 2008 and 2009.
The legislation thus gradually reduces the estate tax during the current decade. It repeals the tax completely in 2010, when there’s no estate tax at all.
In 2011, however, all the changes automatically “sunset” to the 2001 level. The exemption returns to $675,000 and the top rate is once again 55 percent.
The uncertainty over what will happen after 2010 will continue until a new law is passed.
Critical Issue for Construction
“This is a very important, critical, issue for us,” said Christian Klein, Washington, D.C., counsel for the Associated Equipment Distributors (AED), which represents independent equipment distributors. “It’s kind of a perfect storm. The overwhelming majority of our members are family-owned businesses, which tend to be owned by an individual or members of a family. One of the unique features of our industry is that, even if you’re a small business, it is very capital-intensive. Our guys aren’t running flower shops; they own major equipment and rental fleets and tend to hit the exemption limit real quickly. The morbid joke in our industry is that, if you have to die, you may as well die in 2010 so that there will be no tax to pay.
“There has been an awakening in the Senate that the estate tax really does threaten small businesses,” Klein said. “The message has gotten through that this really is not just a partisan issue, and they want to do something about it. We have at least 58 votes, and possibly 60, in favor of repeal.”
Said Heidi Blumenthal, director of congressional relations of the Associated General Contractors of America (AGC) in Washington, D.C.: “Full and permanent repeal of the death tax is a huge priority for us. This year we have quite a few more Republican senators who made it a point during their campaigns that they would vote for this repeal. If they continue to stay with us, and do not go back on their constituents, we have the votes for passing a new law, though the vote in the Senate is unlikely to come before the Memorial Day recess.”
Blumenthal said passing the repeal measure in the Senate requires a “point of order” vote of 60, rather than a simple majority of 51, in order to waive the Senate’s usual procedural rule that the law also provides for funding. The 60 votes also are necessary to override a filibuster, though she said such a filibuster is unlikely.
Nick Yaksich, vice president of global public policy in Washington, D.C., of the Association of Equipment Manufacturers (AEM) said: “We will continue to support permanent repeal with the rest of the industry. Right now, it’s just a bad tax.”
Avoiding Forced Sale
Not knowing when they will die, and unsure if the tax will be repealed, contractors and dealers put many thousands of dollars into worst-case scenario estate planning.
“To avoid forced sale of the company in the event of our untimely death, we have to do a tremendous amount of investigative planning,” said Rich Wagman, 2005 chairman of the American Road and Transportation Builders Association (ARTBA). Wagman said a highway contractor may have to purchase more than $1 million in life insurance as protection.
“Unfortunately, you can’t plan on death or any kind of activity happening in a certain year,” said Blumenthal. “Without permanent repeal this year, contractors can only assume that in 2011 the tax will come back at its 2001 level. We want something permanent so that contractors can take advantage of it. At this point, they haven’t been able to take advantage of it at all because of the uncertainty. It’s like looking at a bowl of ice cream behind glass — you can’t touch it and you can’t eat it.
“Most of our guys will pay thousands of dollars to their CPA or attorney in order to avoid a 55 percent tax that may come at a date they can’t easily determine. Many contractors purchase high-face-amount life insurance policies for protection, with premiums as high as $12,000 to $15,000 per month.”
An AED survey showed that 88 percent of members who had engaged in estate tax planning are continuing to fund this planning despite the movement for permanent repeal.
“If you’re a sensible businessman, you’re not going to dismantle your plan just because there’s a chance that the tax will be repealed,” said Klein.
Freeing Money for Investment
The construction industry has stressed to both houses of Congress that the current law discourages economic growth because firms are wary that revenues will exceed certain amounts and be subject to the tax.
“One of the major issues we hear from equipment distributors is that planning for estate taxes is a major diversion of resources,” said Klein. “Input from our members suggests that permanent repeal of the tax would be an economic stimulus. AED members have spent an estimated $31.32 million on lawyers, accountants and other planners to set up estate plans.”
Another AED study estimated that America’s family businesses spend more than $14.2 billion per year to buy death-tax-related life insurance, more than half of what the tax raised before 2001.
“Among other things, these costs put small family businesses at a tremendous competitive disadvantage to publicly held companies that do not have to worry about death tax liability,” said an AED letter to congressmen. “Sixty-six percent of survey respondents who said they have considered selling their family-owned businesses to publicly held corporations cited the tax as an important or very important factor in their decision … Fifty-six percent said it was an important or very important factor in the tremendous consolidation, which the equipment industry has experienced in recent years.”
Small companies in particular hold back expansion because they worry about hitting a certain level and beginning to pay a tax, said AGC’s Blumenthal, adding: “It may make more financial sense to them to continue at their present size and not take certain risks or opportunities in order to avoid the tax. With the tax out of the way, more companies will be willing to expand and purchase equipment, taking on projects that might have grown them too far and too fast under the present law. They will spend more time on business development and less on end-of-life considerations.”
Tax Break for the Rich?
Critics charge that repealing the estate tax is a tax break for the top 2 percent of taxpayers and would cost the federal government approximately $290 billion in lost revenue between 2010 and 2020, deepening the already-serious deficit.
“It is not a tax break for the rich because it has been shown that not many estates actually pay the tax anyway,” said Blumenthal. “Many people, especially families that own property, set up legal arrangements like limited partnerships among all the family members. These arrangements also limit the liability of one particular person to an estate tax burden. They also have other business advantages. The argument that the Rockefellers and Bill Gates’s will get out of the tax is false because they are not paying it now.”
Blumenthal said that, although there is a high cost associated with repealing the tax, “We believe that repeal will actually bring more money into the U.S. Treasury.
“Every time, especially in the last five years, that Congress has passed a tax cut, it has brought more general funds into the Treasury,” she said. “This will be even greater. Less money will be spent on tax-avoidance and more will be spent on growing people’s businesses. I think you will see a lot of changes in behavior, including some that we can’t even anticipate, because the tax has been in the nation’s mindset so long.
“It’s not as if the revenues won’t be seen by the Treasury; they will just be realized in a different light,” Blumenthal added. “The government isn’t really getting that much from the estate tax anyway. Now, without the tax, it would get money from other sources, like business expansions, and I think you will see smarter decisions on when a company decides to buy or sell. Family members no longer have to do it in terms of a looming deadline of an aging father or mother, but in terms of whether it makes financial sense. At that point, they pay a capital gains tax, which helps the Treasury.”
Replying to the question, “Isn’t death tax repeal just about helping the rich?” an AED legislative issue paper said: “No. When families are forced to sell businesses to pay the death tax, jobs are lost. Seventy-eight percent of the respondents to a 2001 AED survey said that their companies would be forced to lay off workers when the death tax comes due, with 10 percent of respondents estimating that they will have to lay off 50 or more workers.”
Most estates already are exempt from federal taxes. The Internal Revenue Service has reported that 2.11 percent of people who died in 2001 left estates subject to taxation, which increased federal revenues by $23 billion.”
Bush Backs Repeal
In a statement released after the House vote, President Bush said eliminating the tax is “a matter of basic fairness,” adding: “The Death Tax results in the double taxation of many family assets while hurting the source of most new jobs in this country — America’s small business and farms.”
Democrats failed to pass an alternative plan that would increase the exemptions but leave the tax in place for the wealthiest estates (three tenths of one percent of top income earners). The vote was 238-194. The plan would increase the exemption to $3 million for an individual and $6 million for a couple, beginning in 2006. The exemption would increase to $3.5 million and $7 million in 2009.
Democrats argued that revenues from the estate tax could strengthen the Social Security system, offsetting at least 25 percent and possible as much as 50 percent of the shortfall over the next 75 years.
Leaders of the two parties in the Senate have been exploring the possibility of a compromise.
Affect Charitable Giving?
One little-publicized effect of repeal is that it might lessen donations to charities by as much as $10 billion a year, according to a study by the Brookings Institution. The estate tax provides unlimited deductions for charitable giving. Eliminating the tax would eliminate the need for the shelter.
The $10 billion is roughly equivalent to all the grants made by the country’s 82 largest foundations in 2003. CEG