Money Talk

Episode 36

Accumulation Tax and Transfer Tax

Welcome to our listener-supported podcast, Money Talk, uncompromised absolute financial truths behind financial perceptions with host, Ed Sutkowski and Chuck LeFebvre. Let’s listen in.

Chuck LeFebvre: This is Chuck.

Ed Sutkowski: I’m Ed. In today’s session, we’ll deal with the taxes, specifically the accumulation taxes and the transfer taxes.

Chuck: Okay, but first, I have a question for you.

Ed: Sure.

Chuck: Do you happen to know off the top of your head the current limit for social security taxes on payroll? Well, do you know?

Ed: Not off the top of my head.

Chuck: Neither do I, I think it’s 125, $130,000.

Ed: They want to take the lid off, don’t they?

Chuck: Well, that’s part of what’s been proposed, but I think right now, it’s somewhere around $125,000 to $130,000, meaning that, let’s say it’s $130,000, the first $130,000 of your earned income W2 wages is subject to both Social Security and Medicare taxes. Here’s the pop quiz for the day, which is, let’s assume that numbers $130,000, you are a wage earner, and that last $10,000 of income between $120,000 and $130,000, what is your effective marginal tax rate on that income?

Ed: Well, that’s the sum of the payroll. Am I self-employed, or am I with com– Let’s assume I’m self-employed.

Chuck: Well, it’s a little more complicated if you’re self-employed.

Ed: Because you get a deduction for half. Let’s forget about the deduction which is submitted total is about what 15.3%.

Chuck: 15.6.

Ed: Plus, you’re going to have this Medicare tax, except that the Medicare tax is on the full amount. If I have $10 million, and W2, I’ve got a Medicare tax on the full nine years, but the Social Security tax only on this first X dollars. Well, the highest marginal rate, you’re talking about the income tax, the sum of the income tax, it’s somewhere, I’d say somewhere around 40%.

Chuck: It’s 39.6%.

Ed: Call me a liar.

Chuck: Well, it’s interesting, because that just happens to be a number that you keep seeing pop up as the top marginal income tax rate that gets thrown around.

Ed: That’s historical.

Chuck: It’s historical and something that’s been proposed to be brought back.

Ed: Let me interrupt you there because we’re talking about brought back not only for ordinary income but for-

Chuck: For capital gains.

Ed: -capital gains, so we’ll get into that. We’re talking about this segment is the asset accumulation, that is the impact of the income taxes before you get to the accumulation tax.

Chuck: Anyway, I thought this would be a good thing to start the broadcast with or today’s podcast with as, I guess, a point of perspective here because we’re going to be talking about these kinds of confiscatory levels of taxation that are going to apply to people at the very top of the income and wealth scale. Yet, as [unintelligible 00:03:47] said, the very worst taxpayer to be is a working schmuck, right?

Ed: It’s really interesting and expressive because the legislature– Biden’s plan is a tax reform that rewards work, not wealth, interest. You only get the wealth, typically, after you’ve worked. It’s a little upside down as far as I’m concerned, that is the wealth occurs after you’ve worked, but you’re right as terms of the cost, the net cost to the individual who’s the worker bee, which perhaps drives the country, is far in excess of what you think it might be.

Chuck: As you know, my pet peeve is this payroll tax, and I just take at face value, what my understanding is the consensus among economists that even though one half of that is paid by the employer, that it effectively is paid by the employee in the form of having a lower wage because that’s an expense that’s incurred by the employer. That’s a tax that applies to the first dollar that anybody earns and all the way up to that limit number. It’s a regressive tax and it’s a pretty high tax rate, as well. It always gets ignored in these discussions about taxation and where the tax burden lies.

Ed: I can’t imagine why is ignored, but do you think of this I know of a friend client who has a medical reimbursement plan, and one of the employees approached the client and said, the client’s employees said, “Look, what we could do is, I could do this and save you about $300 a month in medical expenses if I do Y, that is my husband will add me to his medical insurance.” My point is that excess, that savings if the employer is smart, will at least share half of it with the employee. It seems to miss the principle that we’re going to look at the upper one, one half of 1% of the top. That’s where the money is, and no, it’s not going to come from there from those people. It’s coming from others, but we miss that.

Chuck: Right, there’s never really a whole lot of revenue generated in many of these tax proposals in the grand scheme of things. I’ve seen some comments about raising maybe $20 billion, or $40 billion, depending on the proposal, from some of these changes to the estate tax, which it’s not that $20 or $40 billion is a small amount of money, but for the federal government, that’s really not a big budgetary numbers. This is more about social engineering than revenue raising.

Ed: Well, I view it as the redistribution of income and wealth, I think of the Thomas Piketty book, Capital in the Twenty-First Century, which was adopted pretty much by Obama and his successors, that we have to redistribute income and wealth, because of this disparity and because of the disparity, those with all sorts of money, control the destiny of the political system, and that’s the extension, the Koch brothers, et cetera. When you have excess wealth, you’re going to control the political process, the democratic process and the world is going to go to hell.

Chuck: Well, but one of the things that, I think is again, people too often ignore the fact that these systems don’t actually redistribute that much either, right?

Ed: Well, because when it goes to the government, and Charlie, the government employee that’s in charge of the redistribution of the wealth, is presumed to have more skill, more intellectual savvy, and knows how to redistribute this money in taxes better than would be the taxpayer.

Chuck: Right, but the other thing is that just the dollar amounts end up not being a significant number in the grand scheme of the scale of our economy, or the scale of total revenues. When you look at what’s really being collected in terms of tax revenue, so much of that is coming from just basic income taxes and payroll taxes, and these changes that get made, that are designed to target 0.5% of the population or 0.1% of the population. They make for a lot of drama on the political landscape, but when we’re talking about really changing the nature of our economy, it’s just the amount of money that’s moving from one place to another ends up being a fairly small amount of money. Think of it this way, if you’re making a change to the estate tax, and it results in $40 billion a year, in additional estate tax being collected, well, how much is Jeff Bezos worth? Compared to that, that’s just one person. What these changes do, cause to happen is a tremendous amount of behavior by private parties in efforts to circumvent or to avoid paying the taxes.

Ed: The compliance cost.

Chuck: I don’t want to suggest that there’s no effect of these taxes being paid, but I think the primary effect is all of the economic activity that’s done in order to avoid the taxes and not so much the collection of the taxes themselves.

Ed: Well, we’ve created jobs. It’s just the sector that’s shown the increase in jobs would be the political section, the bureaucratic section. It’s always easy to give away or take money from others rather than take money from yourself and others. If you have no economic skin in the game, it’s easy to give away someone else’s money. We see that pervasively in the corporate setting, in the 501(c)(3) setting and you get back to where are you coming from? What are you trying to accomplish? Whose money you’re giving away. How did you get that money? We omit philosophically but having said that, let’s think about some of the topics today. We’ve talked about the income tax and the self-employment tax, the payroll taxes, the Obama tax. The biggest issue that I see is ending the capital gain hold tax loophole which is interesting.

Chuck: We can have a whole discussion about that word loophole? That’s the question.

Ed: It’s a charged word. What do you mean by loophole? What do you mean by love? What do you mean by religion? When you get to a qualitative word it’s whatever you think it means irrespective? The room is 13 by 14, that’s quantitative but qualitative this is a nice room. What do you mean?

Check: When I defer income into my 401(k) plan that’s not a loophole. That’s [crosstalk] just part of the tax code. The stepped-up basis at death [crosstalk]

Ed: That’s horrible but the capital gain tax. This person has 33 cents cost basis original purchase price for shares. It’s not worth $100 dollars and it’s a loophole? That’s an inflation adjusted. It isn’t taken into account if you were to increase the rate to reflect– that is, adjust the rate to reflect the increases in the cost of living, be a different story.

Chuck: Maybe we should do this. How about first I’ll recap here, why we’re talking about this what’s been thrown out there, and then we can maybe touch on why it’s an issue. Third, our predictions about how likely this is to actually happen.

Ed: Before we get to that I just want to make sure everyone understands this wealth transfer tax accounts for, at best, 1% of the total revenue.

Chuck: It’s tiny.

Ed: We’re talking about a fly here that’s viewed to be the size of the world, when in fact as you pointed out, the dollars at risk here are pretty nominal. The individual who has accumulated these assets, whether deferred by way of tax-qualified arrangements or simply good investing is the subject of this hurrah. Then when the hurrah’s done, it’s less than 1%. They go ahead with some of the changes that you see check in this, for example, the 99.5% Act which was introduced by Senator Sanders the guy that’s accumulated all kinds of wealth.

Chuck: I have a little bit of egg on my face because I– maybe not too much because what happened is prior to the Biden administration really releasing any of its particular advice about its own tax plans, we had a pair of pieces of legislation that were introduced in the Senate. One of them was referred to as the 99.5% Act. That was introduced by Bernie Sanders. Then around the same time, there was a second bill that was referred to as the STEP Act S-T-E-P Act that was introduced at the same time. My thought when I saw this was that the 99.5% Act was probably introduced with the intent of representing the tax policy that the Democrats were really intending to pass. The STEP Act was intended to be aspirational and maybe just a campaign slogan.

Ed: Let me pull you back. The STEP Act talks about increases in the tax basis at death or taxing appreciation at death. Let’s talk about, in the case of a transfer of appreciated property by gift during your lifetime, your cost basis carries over. Correct. When the donee sells that appreciated property. the capital gains, let’s assume it’s a capital asset which is where we’re talking about, is taxed to the hands of the donee. At death, however, that cost basis is increased or stepped up, or adjusted. Let’s talk about an example. Let’s assume I have $100,000 cost basis in stock of this wonderful company. It’s now worth a million and one and I can either give it away during my lifetime or die with it. I give it away and the donee then sells it. Let’s assume that I’ve held it for more than a year. What’s the tax then, Chuck?

Chuck: They pay the same gain as if you had sold it. They say they pay tax on the gain the same as if you had sold it prior to making a gift of it.

Ed: Under the current law we’re not going to eliminate the capital gain rates but it would be the 20% plus the Obama tax, plus the estate tax, if any, Now I die and I give same asset to my son. That $1 million of untaxed appreciation is never taxed. My son saves 33 to make it easy, a third or $333,000 in income tax. It’s better to die with the asset than give it away during your lifetime.

Chuck: The STEP Act, really the most significant piece of the STEP Act was the concept of taxing these appreciated assets at death. The proposal was to have a $1 million exemption on that as part of that particular legislation. I treated that when reading about it was that it was probably not a serious proposal just because it was introduced side-by-side with this other proposal, the 99.5% Act which appeared to be much more serious. The 99.5% Act, in my mind the most significant piece of that act was the reduction of the basic exclusion amount. Which is the amount of the size of a person’s gross estate that is excluded from being taxed at death or excluded from being subject to estate tax. That was going to be lowered from the current level which is $11.7 million down to $3.5 million.

Ed: I want to make sure that I understand that. We’ve got an income tax to get the money to accumulate it, and now I want to give it away and I can historically give away $15,000 per year for Doni plus unlimited gifts to my spouse, plus unlimited medical payments, tuition payments charitable payments. Then after those are eroded, those are exhausted, I theoretically could give $15,000 to everyone in this building. Now let’s assume there’s 100 people here. I can give away a lot of money with no– I wouldn’t file a gift tax return.

Chuck: Correct.

Ed: Now I’ve exhausted those annual– those are annual limits. Those have been adjusted in part to reflect increase in cost of living per the chart that you prepared some time ago, that annual exclusion back in ’83 was 10,000 all the way up to 16,000 perhaps going forward with 15,000 this year. Will you talk about the exclusion amount that’s after those lifetime gifts, you then can exclude additional amounts whether they’re cash or appreciated property when gifted to third parties other than your spouse.

Chuck: Correct. That additional amount that you can give away either during life or at death, under current law is $11.7 million. Although that is a little bit of a misleading figure because that’s a temporary boost to that number. It is scheduled without anybody passing any new legislation that’s scheduled after the expiration of 2025 or in other words, on January 1st, 2026. That number will drop in half of whatever it’s then current value is going to be. If we just look forward using normal projected inflation adjustments, my own calculation is that again under current law that would drop down to about $6.5 million in 2026 just without anybody doing anything. Now this 99.5% Act what it does is, it says, well, let’s not wait for that to drop down. Let’s just set a new level now and the new level would be $3.5 million. That’s a huge drop when you compare it to the headline number of 11.7 million that we currently have. It’s not as big of a drop when you think of it in terms of comparing it to where we’re ultimately going to be headed with this exemption amount. The other thing that this 99.5% Act does is it increases the or it will, or it would, it proposes to increase what the total amount that you can reduce the size of an estate through what’s called special-use valuation. In other words, typically this is with family-owned farms. The idea is that in counting how much value you assign to a farm in the course of doing an estate tax valuation, you can get a special appraisal that appraises the farm’s value just based on the income it produces as a farm and its so-called highest and best use. Again, it’s a number that adjusts for inflation each year, and it’s hovered at just a little over $1,000,000 for the last several years. This 99.5% Act would increase that to $3 million. That’s a pretty significant increase in what would be allowed as special-use valuation. If you think about it from the standpoint of a farming family if you add the basic exclusion of $3.5 million and what would be the available amount, you could reduce the size of your gross estate via the special-use valuation of $3 million, you could effectively have 6.5 million dollars worth of property. If it’s farm ground that is not taxed under the law created by this so-called 99.5% Act.

Ed: Going back for a moment to make sure that I understand what’s going on here, we have the income tax is the capital gain rate is different than the ordinary income at the self-employment tax. We have the payroll tax, the unemployment comp tax, the estate tax if any. Now we’ve accumulated some money. Now we’re talking about the transfer. The lifetime transfer is these annual exclusions, there may be a limit under the legislation of two times the annual or 30,000 per donor or versus the donee limitations. That inhibits the transfer plus new potential legislation is $1,000,000 exclusion amount versus 3,000,005, or versus $11.7 as we have it now, in other words, that the ability to give away property during your lifetime is more difficult, more expensive than at death. Why would anyone give away any property during lifetime, assuming that the value remains the same?

Chuck: This creates what appears to me to be introducing additional complexity into that decision-making because we have for many, many years that hasn’t always been the case, but it’s typically been the case under laws for the last several decades that the exemption amount, this $11.7 million we keep mentioning has really applied to transfers whether you do it during life or at death. Part of this proposal is to say, okay, you have a $3.5 million exemption for transfers at death, but only a $1 million exemption for transfers during life. Then all these additional rules that apply to how many annual gifts you can make and that kind of thing that makes lifetime gifting quite a bit more complicated for planning purposes than it is under current law. Here’s maybe one answer to your question as to why would anyone give away property during life? It appears to me that under this proposed law just like under current law that the effective tax rate, not the headline or the nominal tax rate, but the effective tax rate for lifetime gifts will continue to be lower than the effective tax rate for gifts at death. There might still be reasons why people would make lifetime gifts, but it’s going to be a lot more complicated to do that planning I think.

Ed: I want to extend that discussion. I think that it’s still a little better to give away during the lifetime because you, the donor pays the gift tax. You’re really not only making versus the estate tax is paid out of the estate, the assets. The gift tax is the responsibility for paying the gift tax absent, a special agreement to the contrary with the donees is the donor the person giving it away. The grandfather has way too much money. That individual not only pays the gift tax, but he reduces his taxable estate by the amount of the gift tax paid. That gift tax be added to the tax basis of the subject asset. Pretty another way, the problem with accumulating wealth, is not the accumulation process. It’s how do you give it away? I’ve had any number of folks with very modest estates saying, “We’ve got fear, greed, the government revenge we’ve got to deal with and irrespective of the size of the asset or the size of the estate, how to give it away, when to give it away, it’s sometimes better not to have money, is that fair?

Chuck: I suspect that that’s probably not literally the case, but I understand what you’re saying. Here’s the thing, Ed, I think that I’m imagining someone listening to our discussion so far and we’ve thrown around all these different numbers and everything in their head is just spinning with all these proposed changes. Tell me if you disagree with what I’m about to say, at least with respect to these changes that are in the 99.5% Act that relate to transfer taxes. Even if you assume all of that were to become law, I’m not saying that it won’t affect people, but as a planner, none of this gives me heartburn. I feel like we’re still talking about what is a voluntary tax system that with planning, there’s lots of planning opportunities here, and we’ve dealt with this regime for so many decades that we have the tools in the toolbox to be able to deal with this. Do you disagree?

Ed: I wish I could. I like to disagree just to be disagreeable, but unfortunately, I can’t disagree. I’ve been doing this in ’63. I’ve seen a lot of changes and the only thing constant is change. The only reason I enjoy what I’m doing is because of that changes. Tomorrow is a different story and yes, we have this administration, it didn’t have an overwhelming opportunity to change everything. It’s a 50-50 split. Let’s think of what’s going to happen in the midterms. The point is it’s changing and yes, but the observations are the same. Are we going to have a change in the step-up in basis? I don’t think so. We’ve had that for decades and that’s disruptive of everything. In other words, if that capital gain that,–I gave you the example, I paid $100,000 for the stock, went to a million and one. I’m a ghost get a basis step-up, save 33% or whatever it is in tax. That’s not going to go away. There’s too many things, plus we have now a cap on exchanges theoretically of $500,000. A whole industry that’s involved in these Code Section 1031 exchanges, they’re going to stand up and yell, “Wait a minute, we’re out of jobs.”

Chuck: I think that there’s genuinely a reason to be skeptical about any of this becoming law as proposed. Some parts of this will become law, but clearly, it’s not all going to become law. Let’s talk about this basis step-up gain at death taxation thing because that seems to be what’s giving a lot of people, a lot of heartburn.

Ed: Oh, wait, I’m going to make sure we’re talking about a capital asset here. We’re not talking about your 401(k) plan or your IRA. Let’s be sure that this is focused on capital assets only.

Chuck: Stock portfolio. [crosstalk] You’ve got a stock or you own a farm or some other asset that is not part of a retirement plan and there are two different concepts that are potential proposals that the press has not done a very good job in my view of explaining to the public that these are two completely different and you can’t have them both. Only one of these two things, either one is going to happen, the other is going to happen or neither is going to happen, but it’s impossible for them both to happen. The two separate things that get bandied about is number one, nothing changes about the current law, except when you die, the people who inherit from you simply do not get that basis step-up that they do under current law. In other words, you own a stock that’s worth $1 million and your basis in it is $1 and you die under current law, whoever inherits that from you has a basis of $1 million. One thing that is at least theoretically possible to change in the law is to say, guess what, whoever inherits that from you, their basis is still $1, the same as yours. That’s just simply eliminating the basis step-up. That is completely different and contradictory to a different idea, which is to say let’s tax that $1 million of gain when you die. I don’t know if the deal is that reporters don’t understand the difference between those two things or if they’re just sloppy with their language, but those are two separate proposals and only one of them can pass because they contradict each other. If you’re going to tax it at death, then the tax is going to create a new basis.

Ed: That’s right. It’s just part of Elizabeth Warren, there was the annual asset tax. If you don’t sell, you’re still going to pay a tax. I have some problems philosophically with this estate tax. I signed a voluntary event. Although, I’ve suggested keep me on the ventilator until this legislation passes from a tax perspective or take me off or whatever. When we had no estate tax in 2010, George Steinberger New York Yankees died. Well, the basis in the shares of the Yankees carried over into the hands of his heirs. Well, is that a good thing or a bad thing? Well, that’s quite different than taxing those shares at the date of his death as you’re pointing out.

Chuck: You don’t have to write a check that someday if they sell that asset, they’re going to have to pay.

Ed: Where there are alternatives. There are all kinds of things you can do. You can get into these long-term trust, but essentially charitable contributions. If there’s an industry that’s opting for this elimination of tax basis step up, it’s the 501(c)(3) industry, the charities, or the life insurance companies. We’ve got to somehow fund either the taxes or say you’ve got some ground that doesn’t produce much income. You’re going to be subject to tax. You’ve got to buy life insurance, provide the heirs with some assets to live on. The industries that are going to succeed, if this Biden proposal is adopted in total, the charities and the life insurance companies.

Chuck: Let me go through this language here, which again, we have some legislation that was introduced, but then that was introduced before the Biden administration published what they’re referring to as the American Families Plan, which is not in the form of proposed legislation, but it’s more like a bullet. It’s more like talking points that have been published and it’s not clear whether the American Families Plan proposes to tax gains at death or merely not provide a basis step-up at death. Let me read exactly what this thing says because it’s an internally inconsistent document. It says the president would eliminate, that’s referring to the fact that there is a basis step-up that occurs at death. It says today our tax laws allow these accumulated gains, meaning untaxed gains during your lifetime to be passed down across generations untaxed, exacerbating inequality. The president’s plan will close this loophole. There’s that word, ending the practice of stepping up the basis for gains in excess of $1 million. Then it says in parentheses 2.5 million per couple when combined with existing real estate exemptions. That’s referring to $1 million for each person the married couple, and then tacking onto that, the fact that you already have $500,000 exemption from capital gains for your personal residence. So far, that just sounds like what they’re proposing is, it says, ending the practice of stepping up the basis for gains. That sounds like they’re saying we’re no longer going to allow this basis step-up to occur. Then it says, and making sure the gains are taxed if property is not donated to charity. That sounds like they’re talking about imposing a tax. It says the reform will be designed with protection so that family-owned businesses and farms will not have to pay taxes when given to heirs who continue to run the businesses. I have no idea and neither does anyone else, by the way, whether this proposal is to tax gains at death or to just eliminate the basis step-up at death. Well, my guess is that what we ultimately will see passed into law will be neither.

Ed: Yes, my bet is it’s changing the basic exclusion amount. That, 11.7 now or reverting to 3.5 or whatever. I want to go back to that because we’ve talked about– I misspoke. I didn’t add an initial tax. We have the income tax, capital gains tax, self-employment payroll taxes, and we have the wealth accumulation tax, the penalties for managing the assets and the like, and then the transfer tax lifetime or at death. We have a generation-skipping transfer tax also. In other words, not only do we have theoretically 11.7 in gift, 11.7 in estate new proposal, a million in gift, and 3.5 in estate, but we have a generation-skipping transfer tax. For example, if I elect to give property to my grandchildren, great-grandchildren, our great, great, great-grandchildren, while under current law, I have the $15,000 per donee exclusion that will be changed, but in excess of that, I have an additional generation-skipping transfer tax lifetime or death. Chuck, how does that work?

Chuck: People confuse that as a tax on to the estate tax or the gift tax, but it is a totally different tax that applies to transfers that go to so-called skip persons. A skip person is essentially somebody who is a grandchild or further descendant. If you make a transfer to a grandchild, let’s just say a grandchild. If you make a transfer to a grandchild, either by way of a lifetime gift or a transfer that occurs as a result of your death, then that implicates this generation-skipping transfer tax system, which has its own set of rules that are very similar to the gift tax and the estate tax, but they’re not identical. They’re similar in the sense that you can, for instance, give $15,000 per year to any individual donee and you can give $15,000 a year away to however many different skip persons you want to in a year with no limit. Then above that $15,000, you start eating into a lifetime exemption, which is the same $11.7 million exemption. It’s the same number, but it’s not the same exemption. It’s not the same tube of toothpaste that you’re squeezing toothpaste out of. You have one bucket here, which is the estate and gift tax. You’ve got an $11.7 million amount exempt from those taxes. You’ve got another bucket over here, which is the same size, it’s $11.7 million, but it’s a completely different bucket. Once you have given away more than $11.7 million to skip people, then a 40% tax applies on any further gifts. Again, it doesn’t matter when you make those gifts either during life or at death,

Ed: I think about a skipper. Let’s say I give away $700,000 to all my skippers.

Chuck: I like that term.

Ed: Yes, the skipper. As in Skipper peanut butter, but I’ve given away seven millions to the skippers, but that erodes my generation-skipping transfer tax exclusion, but it also erodes my basic one. People seem to miss that, you still made a gift. You’re eroding using up your toothpaste in your basic exclusion amount. In addition to that, your generation-skipping transfer amount. You’re going to keep track of them. People think, “Oh, I can give that away and I’m subject to the GST tax.” Sorry, Charlie. You’re subject to both taxes. Unfortunately in the case of the basic, your surviving spouse can use what you haven’t used, but not the GST, that goes away.

Chuck: What typically happens here is that because people will typically give all, or at least most, and if not, most, at least some of their gifts they give to their children or at least the generation that their children occupy rather than their grandchildren. Is that people will typically run out of their basic exemption, the gift tax, and estate tax exemption, and have unused, leftover GST tax exemption that they never really get to tap into because in order to make those generation-skipping gifts, at that point, they would have to pay a regular gift tax. For that reason, the GST tax does not often come into play because people are typically using up their basic exclusion amounts before they ever end up incurring a GST tax. Because the rules and regulations of these two tax regimes are not quite identical, it’s possible in other circumstances to make transfers that count against your GST exemption, without getting into your gift tax exemption. That’s probably a little bit too complicated to get into here today. My own experience is that the generation-skipping transfer tax is a tax that is only paid on accident.

Ed: That’s right. Think about the gift and not the income, but the gift and the estate taxes are voluntary taxes. Let’s get serious. Probate is voluntary. Paying excessive transfer taxes is voluntary. Paying excessive management fees, that’s voluntary. We lose sight of that. They think, well, this is crazy. Yes, it’s crazy. On the other hand, it’s something that can be navigated. It’s not the end of the world, but you’ve got to think about it.

Chuck: Getting back to that comment I just made that you’re expanding on, just to be clear, the way the generation-skipping transfer tax system is set up, is that a person who does absolutely no estate planning or tax planning, whatsoever, if they’re wealthy enough, they will pay an estate tax and possibly a gift tax, but such a person could never pay a generation-skipping tax.

Ed: Should never.

Chuck: Well, if they do no planning, they’re never going to just fall into it. The only way this tax ever gets paid is if someone does some kind of estate planning that drops them into this tax regime.

Ed: Well, let’s talk about that. It’s very important. I think about these long-term perpetual generation-skipping transfer tax trusts. Man, and I use that as including women, a human being likes to leave something behind, whether it’s a building, a job, a grandchild, you’re trying to spread your lifetime over multiple generations. It doesn’t work, but people try that with buildings and scholarships. One aspect and it has attracted a lot of attention is a generation-skipping trust. In other words, you put 11.7 during your lifetime and cash. You keep your appreciated securities. You borrow money against this appreciated security. You pay in effect non-deductible margin interest, in theory, Not in theory, in practice, and you put 11.7 into a generation-skipping trust that lasts so long as you have a descendant. Let’s assume you got six kids, they have three kids a piece, you’re talking about a very, very long time. That would never then be the subject of any gift or estate tax down the line. The problem with that, Chuck, under the legislation?

Chuck: Well, one problem with that is that you never get this basis step-up.

Ed: So what? I’m not paying a tax either.

Chuck: Well, one problem under this proposal legislation is that if the gift tax exemption drops to $1 million, you’re going to be paying gift tax on that transfer into that trust at a pretty substantial level. I’m not sure, Ed, if a generation-skipping transfer tax exemption is supposed to go down to $1 million or $3.5 million.

Ed: Well, the suggestion was it emulates the basic, whether that’s going to be the case. The problem is, most normal human beings really don’t understand the interplay of these three sets of taxes, income, accumulation and distribution taxes. You have to be a little offbeat to want to do this all the time. On the other hand, it is fun because you can demonstrate an avoidance of these voluntary taxes if you care to.

Chuck: Then there’s this other part of the proposal that limits the length of a trust that can be exempt from these taxes. I believe the number is 50 years. This so-called dynasty, the trust that you just described are sometimes referred to as dynasty trust. There would be a tax that’s imposed on any trust that has a length of greater than 50 years. Existing trust will be grandfathered in, but I believe that they’re only grandfathered in for 50 years. In other words, those trusts have to somehow be distributed out within 50 years of enactment of the statute, if there aren’t any changes made in this law prior to passage. Then if such trust or not, by then exhausted, a tax will be applied to them, following that 50-year. It’s not really a grandfather. It’s more like a grace period.

Gordon: Typically we provide that, notwithstanding the duration expressed in the instrument, it terminates one day before the tax would be paid. As you distributed it on down, you don’t know who’s going to get it, which gets to the big philosophical problem that I’ve found that exists, that isn’t necessarily addressed by folks that have accumulated the wealth, whether they’ve won a lottery, whether they’ve inherited property, and whether they’ve earned it, there’s always a possibility that people actually earn the money to get these assets accumulating. I think some of these tax proposals don’t seem to address that. It’s irrespective of the source, if you got money, I’m going to take it. I’m overstating it, but that’s okay. That’s my life. The bottom line here is that the accumulation process should be viewed as a game. This is a game that you’re playing. Are you going to win by your standards, because it’s the game with you and the government and all these tools that are available, long-term trust, fractional interest trust, we could go on and on and on. The bottom line is these proposals do not mean that the taxes must be paid. It’s a game.

Chuck: Most of these taxes really are voluntary taxes at the end of the day. Now, if every single thing that’s been proposed gets passed, they’ll no longer be voluntary. They’re going to capture taxes one way or another from just about everybody who hits the wealth levels that these things target. We are so unlikely to see that happen.

Ed: Well, I’ve always said if all these proposals are passed, I will have a full head of hair tomorrow.

Gordon: The day after they’re passed. It’s not going to happen. The prediction is we’re going to keep basis step-up. It’s got to be kept. We’re not going to have a tax at death. We’re not going to have an annual asset tax.

Chuck: You mean there’s not going to be a capital gain tax at death?

Gordon: Capital gain tax or any tax at death. These exclusion amounts will be changed as been the case, looking at the chart that you created in ’83, the exemption amount, exclusion amount, they changed the nomenclature was 27.5. We had a top rate of 60%. Well, 2018, we had a 40% tax rate, well, 11.2 in effect exclusion amount. Then 2010, we had no tax, no estate tax, no generation-skipping transfer, no gift tax. The point is, relax. The only thing constant about this is change, and it’s a process, and don’t let the process inhibit what you would otherwise do as a human being.

Chuck: Well, and then one more thing is that when you’re listening to or reading news accounts of all of these things swirling around, first of all, those are hardly ever written by people who really understand the tax code or the current tax system. They’re usually just regurgitating somebody’s talking point, but you can usually figure out who’s talking points they are. Second, even the very best media outlets certainly have an incentive to sensationalize this as much as they possibly can. I think there’s a lot of hype surrounding a lot of breathless talk about what’s about to happen and how sweeping these changes are going to be. We’re could conceivably see some changes. We’re certainly going to see some changes. We could see some dramatic changes. It’s really hard for me to conceive of a situation where we’re going to have catastrophic changes that are crippling to people.

Gordon: You know why, the people that pass the legislation have assets.

Chuck: They have assets and they have a lot of friends who are lobbyists. There are a lot of vested interests that are stacked against many of what would be some of the more damaging proposals here. There’s a very thin majority of Democrats in both houses. There’s going to be no Republican support for any of these proposals. There’s a very thin majority of Democrats in both houses and a handful of those are folks that are already expressing their disagreement for big portions of these bills. The horse-trading is just starting.

Gordon: Yes. I think of it why is this occurring? Why are we focused on redistribution of income, redistribution of wealth? It’s been troublesome to me as why is the individual who has created jobs, created wealth being punished for this accumulation process? I’m not talking about the Microsoft people and the Amazon people, not the outliers. I’m talking of the normal human being that has worked for X company, FedEx for 40 years and has a significant estate. Why is this tax being imposed? I’ve come to the realization reading Joe Epstein’s book on envy that that’s what it’s all about. The seven sins are pride, envy, anger, sloth, greed, gluttony, and lust. I think the decisive one is envy and those that have accumulated wealth are envied by those that have not. You’re penalized for using a capitalistic system as we know it to be, and that’s okay, but the point is no– They have 150 people that all live around here. [laughs] You know what I mean? They’re just one of 100.

Ed: You seek out very prolific male shareholders.

Gordon: That’s the takeaway. One consideration before you own stock of One Community Bank, you got to make sure that this individual can breed like rabbits.

Ed: Well, Gordon, thanks for your time, energy, and it’s been a pleasure. Again, best regards.

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Episode 58

With today's program, let's address who's talking. What is the source of the information that you're relying upon? Specifically, should you be listening to someone who's talking? My answer to that is no.