Tax Strategies/ Estate planning

DEATH TAXES!

Understanding the Death Tax: History, Strategies, and Future Outlook

At Drexel and Co. Financial Planning, we recognize that estate planning can be an emotional and complex process. One of the most misunderstood aspects of estate planning is the “death tax,” more formally known as the estate tax. By understanding its history, current rules, and strategic considerations, you can make informed decisions to preserve your wealth and minimize tax burdens for your heirs.

A Brief History of the Estate Tax

The U.S. federal estate tax has a history as turbulent as the lives it impacts. Originally introduced in 1797 to fund the Navy during times of war, the estate tax has been repealed and reinstated numerous times, often leaving families scrambling to protect the wealth they spent a lifetime building. Let’s take a closer look at the key moments, sprinkled with stories that show just how much this tax can shape legacies.

The Early Days: A Tax Born in Crisis

When the estate tax first appeared, the government needed funds to build and sustain the Navy. It wasn’t about taxing the wealthy—it was about survival. But once the war was over, the tax quietly disappeared.

The cycle of taxation and repeal would continue, like an unwelcome guest who refuses to leave. Families would adjust, only to see the tax reappear just when they thought their fortunes were secure. For much of the early 20th century, America’s wealthiest families bore the brunt of the estate tax, and it was designed to fund government needs by tapping into the riches of those who’d “won” at capitalism.


Pre-2000s: A Burden on the Middle Class

For much of the 20th century, estate tax exemptions were low, meaning even moderately successful families could find themselves subject to heavy taxation upon the death of a loved one. Imagine this:

  • A small family farm, carefully nurtured over generations, suddenly faces a massive tax bill when the founder passes away. With no liquid assets to pay the tax, the family must sell off farmland—destroying the very legacy their parents worked so hard to leave behind.

  • Or consider a small business owner who spent decades building their company from scratch. Without proper estate planning, their children inherit not just the family business, but also a hefty tax burden they can’t afford. Many are forced to sell the company to cover the IRS bill, erasing years of hard work overnight.

In those days, it wasn’t just the Rockefellers or Vanderbilts worrying about estate taxes—it was middle-class families, small business owners, and farmers who felt the pinch.


Steinbrenner’s Legacy (2010): Timing is Everything

The story of George Steinbrenner, the legendary owner of the New York Yankees, is one for the history books. In 2010, the estate tax was temporarily repealed—a year-long loophole in the tax code. That same year, Steinbrenner passed away, leaving behind a fortune estimated at over $1 billion.

Had Steinbrenner died a year earlier or later, his heirs would have faced a tax bill of roughly $500 million. But because of perfect timing, his family paid zero in estate taxes.

This story underscores the unpredictable nature of estate tax laws and highlights how timing—often beyond anyone’s control—can make or break generational wealth.


Post-2010 Adjustments: The Rise of Portability

In the wake of the Steinbrenner loophole, lawmakers reintroduced the estate tax in 2010 with a few key changes. One of the most significant was portability. Before portability, couples had to rely on complex legal strategies like marital trusts (also known as A/B trusts) to ensure both spouses’ estate tax exemptions were used effectively.

What is Portability? Portability allows the surviving spouse to “inherit” any unused portion of the deceased spouse’s estate tax exemption. It simplifies estate planning and gives families an easier way to protect their wealth.

Why It Matters

  • Without portability, couples risked wasting a significant portion of their estate tax exemption.

  • With portability, a married couple in 2023 could shield up to $25.84 million from federal estate taxes—far more than was possible in the pre-2010 era.


Portability: A Modern Estate Planning Tool

Portability allows the unused portion of a deceased spouse’s estate tax exemption to transfer to the surviving spouse. This development simplifies estate planning, reducing the reliance on complex marital trusts previously required to achieve the same result.

Marital Trusts and Portability

Before portability, couples often used marital trusts (A/B trusts) to ensure both spouses’ estate tax exemptions were fully utilized. While these trusts still have their place in certain scenarios, portability has streamlined planning for many families, allowing more flexibility without the need for trust administration.

Federal vs. State Estate Taxes

Estate tax planning becomes even more nuanced when considering state-level taxes. While the federal estate tax exemption is currently $12.92 million per individual (2023), many states have their own, often lower, thresholds. Notably:

  • Federal Estate Tax: Applies to estates exceeding the federal exemption amount, taxed at rates up to 40%.

  • State Estate Taxes: States like New York and Massachusetts have estate tax exemptions as low as $1 million, significantly broadening the reach of the “death tax.”

  • Inheritance Taxes: Some states, such as Pennsylvania, impose an inheritance tax, which is levied on the beneficiaries rather than the estate itself.

Step-Up in Basis: A Crucial Benefit

One of the most favorable aspects of current estate tax law is the step-up in basis. This provision allows inherited assets to be valued at their market price at the time of the owner’s death, potentially eliminating capital gains tax on appreciated assets held by the decedent.

Example:

If a parent purchased stock for $100,000 and it’s worth $500,000 at their passing, the heirs receive a stepped-up basis of $500,000. If they sell the stock for that amount, they owe no capital gains tax.

Per Stirpes Distribution and State Variations

“Per stirpes” is a legal term used in estate planning that dictates how assets are distributed if a beneficiary predeceases the grantor. Instead of the deceased beneficiary’s share disappearing, it is divided equally among their descendants.

State-Specific Considerations:

Some states automatically apply per stirpes distribution unless specified otherwise, while others require explicit language in the estate plan. It’s essential to consult state laws to ensure your intentions are executed correctly.

The Future of the Estate Tax

The estate tax exemption is set to sunset in 2026, reducing the federal exemption to approximately $6 million (adjusted for inflation). This change will likely expand the number of estates subject to taxation. Additionally:

  • Political Shifts: Changes in administration or congressional priorities could lead to further adjustments in exemption thresholds or tax rates.

  • State Trends: More states may introduce or adjust estate and inheritance taxes to address budget shortfalls.

Strategies to Minimize Estate Taxes

  1. Annual Gifting: Use the annual gift tax exclusion ($17,000 per recipient in 2023) to transfer wealth tax-free.

  2. Irrevocable Trusts: Remove assets from your taxable estate while retaining control over their distribution.

  3. Charitable Contributions: Donate to charities to reduce your estate’s taxable value and support causes you care about.

  4. Life Insurance Trusts: Use irrevocable life insurance trusts (ILITs) to exclude life insurance proceeds from your taxable estate.

  5. State-Specific Planning: Work with an advisor familiar with state laws to navigate additional tax implications.

Why Choose Drexel and Co. Financial Planning?

Estate planning is about more than minimizing taxes; it’s about securing your legacy and ensuring your wishes are honored. At Drexel and Co., we specialize in crafting customized plans that address both federal and state tax considerations, incorporating tools like portability, trusts, and step-up in basis to protect your wealth.

Schedule a consultation with us today to ensure your estate plan is comprehensive, tax-efficient, and aligned with your goals.

Citations

  1. Internal Revenue Service. (2023). Estate and Gift Taxes. Retrieved from https://www.irs.gov

  2. Tax Policy Center. (2023). History and Projections of Estate Tax Exemptions. Retrieved from https://www.taxpolicycenter.org

  3. National Conference of State Legislatures. (2023). State Estate and Inheritance Taxes. Retrieved from https://www.ncsl.org

  4. Financial Planning Association. (2023). Portability and Estate Tax Strategies. Retrieved from https://www.financialplanningassociation.org

  5. Cornell Law School. (2023). Per Stirpes Distribution. Retrieved from https://www.law.cornell.eduThe U.S. federal estate tax has a history as turbulent as the lives it impacts. Originally introduced in 1797 to fund the Navy during times of war, the estate tax has been repealed and reinstated numerous times, often leaving families scrambling to protect the wealth they spent a lifetime building. Let’s take a closer look at the key moments, sprinkled with stories that show just how much this tax can shape legacies.

    The Early Days: A Tax Born in Crisis

    When the estate tax first appeared, the government needed funds to build and sustain the Navy. It wasn’t about taxing the wealthy—it was about survival. But once the war was over, the tax quietly disappeared.

    The cycle of taxation and repeal would continue, like an unwelcome guest who refuses to leave. Families would adjust, only to see the tax reappear just when they thought their fortunes were secure. For much of the early 20th century, America’s wealthiest families bore the brunt of the estate tax, and it was designed to fund government needs by tapping into the riches of those who’d “won” at capitalism.


    Pre-2000s: A Burden on the Middle Class

    For much of the 20th century, estate tax exemptions were low, meaning even moderately successful families could find themselves subject to heavy taxation upon the death of a loved one. Imagine this:

    • A small family farm, carefully nurtured over generations, suddenly faces a massive tax bill when the founder passes away. With no liquid assets to pay the tax, the family must sell off farmland—destroying the very legacy their parents worked so hard to leave behind.

    • Or consider a small business owner who spent decades building their company from scratch. Without proper estate planning, their children inherit not just the family business, but also a hefty tax burden they can’t afford. Many are forced to sell the company to cover the IRS bill, erasing years of hard work overnight.

    In those days, it wasn’t just the Rockefellers or Vanderbilts worrying about estate taxes—it was middle-class families, small business owners, and farmers who felt the pinch.


    Steinbrenner’s Legacy (2010): Timing is Everything

    The story of George Steinbrenner, the legendary owner of the New York Yankees, is one for the history books. In 2010, the estate tax was temporarily repealed—a year-long loophole in the tax code. That same year, Steinbrenner passed away, leaving behind a fortune estimated at over $1 billion.

    Had Steinbrenner died a year earlier or later, his heirs would have faced a tax bill of roughly $500 million. But because of perfect timing, his family paid zero in estate taxes.

    This story underscores the unpredictable nature of estate tax laws and highlights how timing—often beyond anyone’s control—can make or break generational wealth.


    Post-2010 Adjustments: The Rise of Portability

    In the wake of the Steinbrenner loophole, lawmakers reintroduced the estate tax in 2010 with a few key changes. One of the most significant was portability. Before portability, couples had to rely on complex legal strategies like marital trusts (also known as A/B trusts) to ensure both spouses’ estate tax exemptions were used effectively.

    What is Portability? Portability allows the surviving spouse to “inherit” any unused portion of the deceased spouse’s estate tax exemption. It simplifies estate planning and gives families an easier way to protect their wealth.

    Why It Matters

    • Without portability, couples risked wasting a significant portion of their estate tax exemption.

    • With portability, a married couple in 2023 could shield up to $25.84 million from federal estate taxes—far more than was possible in the pre-2010 era.


     

"The problem with estate taxes is that you can’t take it with you, but they make sure your kids can’t have it either."
Will Rogers

-Aristotle

Having an honest, trusted, and knowledgeable advisor who can help you make smart decisions and create a path to your financial goals is the best way to secure your future and the future of those you care about.