By Scott Keffer
“You can’t make me!” I yelled. Bold words for someone who was in the midst of a tussle with his brother—who happened to be older, bigger, stronger—and on top. The 18 months difference in our age didn’t explain everything. He seemed to be better at everything: smarter, better looking, more athletic and very winsome. But I wasn’t ready to throw in the towel—on that day—or ever!
As I have worked over 20 years helping affluent individuals and families control more of their wealth, I must say that most of them, at least initially, seem to have “thrown in the towel” in regard to estate taxes.
Take Bob Magness as an example, the patriarch of TCI, the world’s largest cable TV empire. The Denver Post reported that he was “so smart in life,” but “so foolish in death.” In a related article, John Accola, a Rocky Mountain News reporter, wondered, “Was it really his intention to hand off more than half his nearly $1 billion fortune to the U.S. government?” I can’t imagine it was!
So where did estate taxes come from, anyhow? The Revenue Act of 1916 introduced a graduated tax rate to be applied to a person’s net estate at death. Opponents of the tax appealed to the United States Supreme Court, arguing that it was an infringement on the States’ right to regulate the process of transferring property at death. However, the constitutionality of the tax was upheld, and the Federal estate tax became a permanent element of the U.S. tax system.
Since then, many changes have been made, including the introduction of a gift tax. However, The Tax Reform Act of 1976 established a unified estate and gift tax rate schedule. Under prior law, the tax rate for transfers at death had been significantly higher than the rate for gifts made during life. The unified system now means that gifts made during life and transfers made at death are taxed at exactly the same rate, somewhere between 37 percent and 55 percent. Which, by the way, adds up to some pretty big numbers. Just between 1995 and 1997, the IRS collected almost $50 billion in estate taxes!
So what am I talking about: your choice? Where’s the option? Professor A. James Casner, an expert witness before the House Ways and Means Committee, testified, “In fact, we haven’t got an estate tax, what we have, you pay an estate tax if you want to; if you don’t want to, you don’t have to.”
Furthermore, George Cooper, a Columbia law professor trained in the art of estate taxes, conducted a study on estate taxes as a member of The Brookings Institution associated staff. His findings were first published as an article in the Columbia Law Review and later as a book entitled A Voluntary Tax?
He observed, “Estates and gifts have been subject to taxation by the U.S. government for decades. For most of the past generation, that rate of tax has been as high as 77 percent. Yet, because the owners of great wealth retain estate planners skilled in legal stratagems for tax avoidance, the estate and gift tax laws have never seriously interfered with the intergenerational transfer of large fortunes.”
For example, William Du Pont, Jr., great-grandson of the founder of E. I. Du Pont de Nemours & Company, left each of his five children more then $50 million when he died in 1965. Their aunt, Marion du Pont Scott, arranged to leave them an additional $40 million, leaving these five children with almost a half a billion dollars, valued in 1966 dollars. Yet, total estate and gift taxes paid on that entire sum were around $25 million, a paltry five percent!
Cooper found many examples like the Du Ponts, leading him to conclude: “The perhaps surprising conclusion compelled by our findings is that today’s multimillionaires, as well as persons of lesser wealth, need pay a stiff estate and gift tax no more than did their predecessors. It may be that the real certainties of this world are death and tax avoidance. For those who do not want to contribute their estates to the government, there is an impressive array of strategies for moving wealth from one generation to another outside the purview of estate and gift taxation.”
And yet, almost every affluent family or individual that we have encountered is either unaware that they have a choice or have failed to exercise their choice. Maybe they believe that these options are only for the mega, mega-wealthy.
Dr. Helen G. Rendall was one such individual (a composite of many individuals). She is a divorced physician with a love for her profession and for her family. Though she was once married, she was unable to have any children. So her sister’s children are her family. She spends holidays with them, and enjoys them as if they were her own. Although she had planned for her own future over the years, she did very little planning for her nieces and nephews. She had said to herself, “Whatever they’ll get will be a bonus, much more than I ever received.” Now she knows that she had felt that way because she believed that she had no other options.
That snowy night at the restaurant changed her mind. She heard that there are options, that taxes are voluntary, that she could control more of her wealth, that she could leave more to her heirs and nothing to the IRS.
It also exposed some critical issues of which she was unaware. First, that double taxation would wipe out 75 percent of her retirement assets and a large portion of her annuities. Second, living in eastern Pennsylvania and passing her wealth to her nieces and nephews would mean a state inheritance tax of 15 percent. Third, she was unnecessarily wasting some her $675,000 lifetime credit every year because the life insurance she bought to help her heirs pay the tax was incorrectly designed and owned. Last, under her current plan, $2 million of her $4 million would be lost to taxes, a whopping 50 percent.
She also learned of some powerful tools and strategies that the mega-wealthy have been using for years that would allow her to create a second, tax-free estate and leverage her wealth to her heirs. The result for Helen was peace of mind and more control of her wealth. It enabled her to exercise her choices: to eliminate estate taxes, to leverage her wealth and create a legacy for her nieces and nephews of $3.5 million, and to use philanthropic tools to leverage and create a $2 million legacy for charity.
In addition to creating a lasting legacy for her heirs, she began dreaming about the difference that she is going to make in the community through gifts of food at the local food bank, scholarships at her alma mater and additional facilities at the local hospital.
She now understood what was meant that night at the restaurant: the difference between Involuntary Philanthropy and Voluntary Philanthropy. Before her journey, she had been an Involuntary Philanthropist, scheduled to make a $2 million contribution with absolutely no control over where and how it would be distributed. Now, she is a Voluntary Philanthropist, scheduled to make a $2 million contribution with total control over how those dollars will be used.
The accountant Alwin Ernst, of Ernst & Ernst, left an estate of $12.6 million and lost over $7 million to taxes and costs—over 56 percent. William Randolph Hearst, the publisher, left an estate of $53 million and lost only $3 million to taxes—just 6 percent. Helen Rendall, the doctor, with an estate of $4 million today, will now lose nothing when she passes away and will leave a bundle to those she cares about the most. How about you: 56 percent, 6 percent, or 0 percent? It’s your choice. Don’t throw in the towel!
Scott Keffer is president and founder of Wealth Transfer Solutions, Inc., a legacy planning company in Pittsburgh.