Wealth and Taxes

Not different rules, but rules only a few understand

Cathy McMorris Rodgers (U.S. Rep from Congressional District 5, eastern Washington) sold the all-Republican Tax Cuts and Jobs Act of 2017 to her voters by talking endlessly about “money in your pocket.” This pocket money phrase focused on the skimpy reductions of income tax rates on wages and salaries reportable on W-2s. These same tax rate reductions were scheduled to expire in 2025 (something she steadfastly avoided talking about). Publicly McMorris Rodgers and her fellow Republicans barely acknowledged the decrease in taxes on corporations, a decrease not set to expire. When pressed, Republicans defended these corporate tax cuts as necessary to attract jobs back to America. Republican propaganda-meisters understood that most people, once focused on their own finances, would ignore the details. 

The Tax Cuts and Jobs Act is immensely complex, with a plethora of other provisions, some of the expiring in the near future, that, understandably, hardly anyone noticed except those affected. 

One of those expiring provisions was a long sought goal of Republicans: raising the estate tax exemption. For years Republican propaganda focused disingenuously on the supposedly disastrous effect of estate taxes on passing the value of family farms to the next generation. Bolstered by this propaganda, Republicans had hoped to make their wealthy donors happy by abolishing estate taxes entirely. Unfortunately for them, on account of the constraints of the reconciliation process they had to settle on doubling the estate tax exemption (threshold) to an inflation-adjusted 11.7 million dollars (in 2021)—but to do even that they also had to let it expire and return to a 5.6 million exemption for the estates of those who die after January 1, 2026. 

Most Americans barely noticed the estate tax provisions, since very few will possess even the lower amount, a 5.6 million dollar estate, when they pass on. Those few who did notice the estate exemption changes probably felt good about saving the fabled family farms of Republican propagandists. It’s all about how things are framed. 

In 2019, after passage of the Tax Cuts and Jobs Act, only 4,100 of the 2,800,000 Americans who died that year reached the 11.7 million dollar estate threshold and had to file an estate tax return. That’s less than 1%, specifically, just 0.15% of estates. Of course, that 4,100 didn’t include those who managed to whittle down their estate values to below the 11.7 million dollar exemption using every arguably legal means to shield money from the tax collector. 

Most Americans, those of us who make an hourly wage or salary and receive a W-2 at the end of the year, don’t need to worry about strategies to keep their estate below either level of exemption. We don’t have the time or expertise to enter the arcane world of legal estate tax avoidance. Out of sight and out of mind. 

Let’s dream for a moment that we have an estate that might be worth 13.7 million dollars, 2 million more than the exemption, once we tally up a primary residence, a vacation home, rental properties, appreciated stocks and bonds and bank accounts. If that were the number at the time of our death, those extra 2 million dollars would require a payment of $745,800 due in estate tax. Fifty or sixty thousand dollars spent on the services of specialized tax attorneys and tax lawyers might save us ten times that amount if they could figure out legal angles to diminish the paper value of such an estate. 

First off, the value of real estate or a private business is always debatable to some degree. The “right” appraisals could help a lot. (You know you’ve entered a different world when an appraiser starts out by indicating that the value might be different depending on the purpose of the appraisal. You can’t do that with a bank account…) Then there are a variety of trusts, legal/financial vehicles that offer estate tax avoidance (and other) advantages in transferring wealth to heirs. 

Among the more arcane of these trust vehicles is something called a Grantor Retained Annuity Trust (GRAT). Let me walk you through this beauty as I best understand it. Let’s pretend we’re one of the super-wealthy with millions or billions of dollars more than the exemption, far more money than we need even for our lavish lifestyle. Imagine one chunk of that wealth consisting of stocks and bonds valued at 1 million dollars. Without some form of shielding, that value would require payment of $400,000 in estate taxes at the time we die. With the help of a tax lawyer we put that million dollars worth of stocks and bonds into a GRAT. This “Grantor Retained Annuity Trust” will pay us back $100,000 plus some small IRS-specified rate of interest each year for ten years, such that the original million plus its nominal interest all comes back to us over those ten years (that’s the “annuity” part). Paying a lawyer to set this up seems sort of expensively pointless, doesn’t it? But wait. If those stocks and bonds have been growing in value over those ten years in excess of the paltry IRS-specified interest rate (which seems likely based on years of recent stock market performance) after fully paying the annuity back to me there might be monetary value left in the GRAT. Here’s the trick: When the GRAT is set up an heir(s) is specified who, at the end of the term of the GRAT, will receive excess value remaining in the GRAT—and that value is free of gift and estate taxes. (For legal purposes, a GRAT, once established, exists outside of our estate.) If the value of the assets in the GRAT decreases (as they might have anyway were the assets outside the GRAT), then the value of the annuity is less and the heir gets no benefit. The estate tax utility of the GRAT is a bet on an overall increase in the value over the GRAT’s term. A properly executed GRAT is described as a “heads I win, tails we tie” proposition (minus the money paid to advisors for set up and maintenance of the trust). (Click that link for more detail and real-life examples.)

An ultra-wealthy person once said, “If you can put an accurate number on what you are worth, then you are not wealthy.” In the world of this sort of wealth values are slippery, and estate tax avoidance is a game played not by different rules but rules buried in the legal fine print only a few understand. The rest of us are busy with W-2s displaying fixed, unarguable sums subject to annual income tax. Meanwhile, the wealthy grow more wealth in bonds, stocks, business, and real estate, wealth mostly subject only to the lower capital gains tax rate—and subject to capital gains tax only when it is sold. The ultra-wealthy then pay accountants and lawyers to plot maneuvers that will pass along that wealth while avoiding estate taxes to the greatest degree possible under the interpretation of existing tax law. Meanwhile, the gap between the wealthy and the workaday world ever widens. 

Closing the GRAT loophole was just one of the reforms on the agendas of Bernie Sanders, Elizabeth Warren, and other progressives, agendas expressed in bills that not one Republican in Congress will vote for and of which most Republican voters (and a lot of Democrats) are oblivious. Many pin their hopes for redress on the words of a tax cheat who says that he, being rich himself, knows how to “fix” the loopholes and, instead, delivers the Tax Cuts and Jobs Act for himself and his rich buddies.

There is something very wrong with this picture. Getting it right will require changing the mindsets of many in both parties—and voting current Republicans out of office.

Keep to the high ground,