Tax Treatments of Inheritances in the United States

Introduction

Taxation is a major practice in all countries across the world whether developed, developing, second world or third world. It forms the backbone of every economy. Taxation comes in different forms and varies widely from one country to another. The idea of the taxes of inheritances roots back to ancient Egypt long before the birth of philosopher Benjamin Franklin (Hans flick, 1996). Inheritance taxes are taxes that are levied upon transfer of property to the heir, upon the death of the former (OECD, 2008). In the United States of America, both inheritance and estate taxes are levied. The federal government levies the estate taxes while the state authorities excise the inheritance tax.

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The taxes of inheritance have had varied effects on different economies and as such different states have reacted differently to the taxes. Countries which felt that the taxes were impacting negatively on their economies opted to do away with them all together or expressed strong intentions away with it (Commission of taxation and Copenhagen, 2000). In the United States of America the taxes also have had varied impacts on the economy. Taxpayers across the board reacted differently to the taxes, some saying that it was too high and vulnerable to double taxation. The new United States government has expressed dissatisfaction with the estate tax and as well intends to do away with it starting from January 2010 (William G and Benjamin H(Ed), 2007). In this paper therefore we look in to the treatment of taxes of inheritances in the United States and the effect of these treatments to economic growth.

Background

Inheritance duty started being levied long before the prehistoric philosopher Benjamin Franklin was born. Initially the tax of inheritance was practiced by the ruler of ancient Egypt. The tax at those times was founded and practiced under a well developed law of inheritance and series. From those ages, taxes of inheritance are still being levied under similar taxation principles (Hans flick 1999)

In the United States of America, both the inheritance tax and the estate tax are exercised under taxes of inheritance. Inheritance taxes are those taxes which are paid by individuals who have inherited property from a dead person. The tax is computed independently for each beneficially hence each heir is bestowed with the responsibility to pay his or her own taxes. In the United States of America the inheritance tax varies from one state to another. In some states for instance, the inheritance tax charged in case the beneficiary is either the wife or the child to the deceased is usually lower than if he or she was not (OECD, 2008).

On the contrary, estate tax is that total tax that the federal government levy on the estate which is to be inherited. It is however the responsibility of the person responsible for the estate or the deceased trustee to pay the estates tax. Such a person fills one estates tax return form hence he will pay the estate tax from the money obtained from the estate. In cases where the executor has absconded to pay the estate tax, its inheritor(s) will be held directly responsible to pay the taxes. All citizens and inhabitants of the United States of America are under the obligation of federal government requirement to pay estate tax, which is contrary to the inheritance tax, which is not compulsory requirement by the federal government according to the United States tax directory. All the states in the United States of America hold their own inheritance and estates taxes apart from Texas (commission of taxation and Copenhagen economists, 2000)

Inheritance tax planning (States of America)

This is a strategy that has been devised to help inheritors pay as little taxes as possible on the properties they inherit. It makes use of the available effective legal means to minimize the tax payable on the inheritances. Inheritance tax planning can provide a means to ensure that the beneficiaries do not face temporal financial hardships after the death of the principal. Effective inheritance tax planning requires the planner knowing the types of the assets subject to inheritance taxes levy. Examples of assets which are subject to the payment of inheritance taxes in the United States include homes, apartment buildings, and office buildings, large payments from pensions and life insurance payments. In addition the planning will require an individual to know all the allowances that may be connected with the identified asset. A case may arise for instance where it is possible for the heir to be receiving certain benefits or rather allowances from an inherited property without inheritance taxes being applied forthwith. In the United States of America, inheritance tax in such a circumstance is usually deducted from the total amount received. Inheritance duty planning enables the planner to arrange the estate in a manner that minimizes the tax weight for the heir or rather the beneficially. In the US the legal counsels and financial planners have devised a very effective strategy to achieve this objective. In the strategy a trust is established instead of giving cash disbursements to the beneficiaries. Alternatively, they set up a family company that will see to it that the heir/beneficially receives cash in piecemeal spread over a long duration.

Taxes of inheritances are however challenging to collect and administrate, countries that levy these taxes have cried foul of the pitfalls experienced in the practice. The United States is no exception. Problems that are associated with the collection of these duties are numerous. One, it is a mounting challenge to accurately register all deaths and inherited properties for the purpose of making the taxes system efficient. It is indeed difficult to accurately know who has died where and which property has been heir hereto. Most systems that are currently being used in the registry offices do not have adequate controls. Also, there is the itching problem of double taxation often associated with the taxes of inheritance; it is argued that if an estate is taxed and then immediately inherited by a new heir, then it will be subject to another similar levy thus amounting to double taxation.

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Determining the real value of the estate to be subjected to the estate or inheritance tax is not a simple process. In fact, it is usually a complex procedure and in many cases causes unprecedented disagreements between the parties involved. This process is very tasking especially in countries that lack a well developed private sector system. Another major problem associated with inheritance taxes is that it is very costly to administer. This is because to effectively run this kind of a tax system, the revenue authorities will have to set up very many tiny centers to collect it as well as to record deaths and value properties. In fact, the total cost of administration goes even beyond total tax revenues that the federal government gets from these taxes. Due to the many problems associated with the taxes of inheritance, a number of countries which previously levied taxes of inheritances have found it not worthwhile hence have ended up leaving it all together. For instance, Argentina abolished inheritance taxes in 1976 and instead introduced annual wealth tax on domestic property. Despite the problems, taxes of inheritance are still being levied in the United States. In fact, the United States is one of the few countries that still levies two taxes on inheritances.

The Tax Treatment of Inheritances in United States

In the United States, there are two types of taxes of inheritances that are payable by the inhabitants thereto i.e. both the estate taxes and the inheritance tax although the two terms have been use interchangeably. Interestingly, there is a clause that allows the matrimonial heirs to enjoy full inheritance tax exemptions on condition that they live in the estate in question until and after the death of the owner to the estate in question. The bad bit of collection of inheritance taxes is lack of uniformity in its collection. Although, imposed by the federal government each state has an independent inheritance taxes system with exceptions to Texas. This means that there is a high possibility of inhabitants of different states paying varying amounts of taxes on the same inheritances.

Calculation on inheritance/ estate taxes

Inheritance taxes are levied as a percentage of the property subject to taxation. The percentages are well enacted and specified in the United States laws. A clear blueprint to reduce the top estate tax mark to zero was set up in the year 2003 when the congress enacted laws that were to see the two rates (then 49%) brought down by one % every year to 45% in 2009 and ultimately abolished as from 1, January 2010. In a seminar study on thne responsiveness of death rates to inheritance taxes changes, a plan to introduce a series of changes on the United States estate taxation law was unearthed. According to Atkinson and sleemond (2003) the United States new government had already instituted a law to abolish inheritance taxes starting from the 1st of January 2010. They further noted that under the current United States taxation law, an individual who poses an estate of property with value that exceeds $ 3.5 million was liable to pay a 45% of that value in case such a person passed a way in the last week of the year 2009. However the same individual would pay no tax on the same property, should he or she live until midnight of the following year (2010) (Atkinson and Sleemond, 2003).

The law of inheritance taxation in the United States however, lacks clarity and organization. It is a set of registration that contains the greatest number of exceptions and exemptions than any other United States taxation law thus limiting it to apply to a very small number of United States citizens. The property or the assets for instance has to be in excess of $ 1.5 million to enter the bracket that qualifies for inheritance tax levy. The law also gives complete inheritance tax exemptions to the first class relatives of the deceased who are specified herein as the wife to the deceased, his children, his parents, grandparents as well as his/her grandchildren (IRS publication 2004)

Taxes Of Inheritances And The Economies

In many countries across Europeans South America as well as in Australia and Canada, the taxes of inheritances have been voided as having negative effects on the economy of the particular countries. According to the sources from these particular countries, the inheritance taxes hand proved to be a no enterprise at all. From the international eye the taxes were largely blamed for hindering entrepreneurship and private investments due to the fear of post entrepreneur deaths’ costs (that they were believed to cause). The demise of the entrepreneurs was believed to come with verve wrecking high inheritance and estate costs which could go to an extent of calling for the business liquidation or sale of the business capital assets to afford to pay.

Historically those countries which felt that the inheritance taxes were being a thorn in their feet due to the economic and social harm opted to do away with it or showed a strong intention to abolish it at the earliest opportunity (commission of taxation and Copenhagen economists, 2000). Economist mounted a strong campaign for the abolishment of inheritance taxes in Australia in the 1970s; something that he says was achieved in early 1980s both at federal level as well as in the particular states within Australia (Beer at al 2006). In Argentina, the inheritance taxes were done away with in 1976 and in its place the government introduced what was referred to as the yearly on household’s wealth. In Canada, taxes of inheritances were abolished in most of its seas in the 1970s and then changes were introduced to include a taxation clause referred to as the purported capital appreciation after death. The new American government is not to be left back either. There is already a law that intends to phase out estate tax in the United States come 1st of January the year 2010.

There are several characteristics of taxes of inheritances that perhaps makes it a hindrance to economic development. One, they are very vulnerable to double taxation. For instance in a situation where inheritance/ estate tax is imposed on top of the ordinary income tax, the owner of the property will obviously be overburdened with tax debts this will limit investments and in return derail economic growth (commissioner of taxation, 1999). In addition, inheritance taxes are very expensive to administrate. They require very many centers to effectively cover the tax collection and registry center. It is therefore very costly as at time the expenses have been reported to exceed the tax revenue on inheritances. In such a case then they will be an economic loss to the country. A big attribution to this high cost is the dis-uniformity of the tax systems. According to the European commission and Copenhagen economics (2000) standardized taxation systems are better and cheaper relative to those which vary from state to state.

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Taxes of inheritance and the United States economic growth

The economic development and growth of any given economy is directly proportional to the level of its national income. Economic excellence is indeed the balance between the revenue and the expenditure of the nation. Governments across the globe largely rely on the tax revenue as the key source of income which is in return used to spearhead economic growth in the country and beyond. Taxation revenue and policies are key to any one country’s economic development (OECD, 2008). Although inheritance taxes in the United States are barely believed to contribute any significant amount to the federal revenue kitty it is expected that any tax revenue will improve the total taxation collection of a country and the case of inheritance taxes in the United States are no exception. The brainchild behind their introduction in the United States tax grid was that they would provide additional income to the country’s revenue vital for economic growth.

According to the OECD journal on taxation and economic (2008), the economic contribution of the inheritance funds to the economy of the United States of America is notably negative. The administration cost of estate taxes and inheritance taxes in United State were very high and proposed that the best policy would be to do away with them all together (citizens guide for 2008 elections and beyond, 2007) the cost was this high because of two major reasons. First, the taxation system was not standardized and collection varied from state to state with some e.g. Texas lacking an inheritance tax collection system all together. Secondly, there were no adequate measures to counter evasions which were believed to be a common place in the United States. In addition, very little control systems which were seemingly ineffective were in place to ensure that the taxation was efficiently implemented, According to the European commission and Copenhagen economist 2000’ a standardized taxation system could be more effective both in administration cost savings as well as to winning the trust and confidence of the taxpayers.

The contribution made by the inheritance taxes as a percentage of the total tax revenue in the United States of America is extremely Insignificant. According to Hans flick’s comparative report on contribution of inheritance tax to the country’s total tax, there were only four countries whose inheritance and gifts taxes revenue contribution to the total country’s tax revenue had reached to and even exceeded the 1.5 % mark. The United States was not one of them and this show how inconsequential is the contribution of the inheritance taxes to the tax kitty. The four countries were Belgium, Japan, Greece, and France with 1.5%.1.6%, 1.7%, and 2.0% respectively (Hans’s flick1999)

The current United States law of inheritance taxation could be a possible cause of people delaying death in an attempt to avoid paying the high taxes associated with the taxes. For example, the today’s law required that an owner of property of and in excess of $3.5 million to pay inheritance tax of up to 4 5% in case such a person dies before the midnight of the year 2009. On the other hand, should the person die in first hour of 1st January 2010, he will pay no tax whatsoever on the same asset. This aspect could see people delaying deaths at least to the midnight of 2010 to avoid the tax or together (commissioner of taxation and Copenhagen economists, 2000).

Possible positive effects on inheritance taxes in the economy of United States

Although the taxes of inheritances are deemed to yield only negative result, there are quotas who feel that they have their positive side. According to Atkinson and Slitgiz (1976), inheritance and gift taxes served as efficient recipes in solving the prevalent problem of unbalanced distribution of wealth between the haves and the have not. Heer (2000) acknowledged that the introduction and levying on the taxes in any economy brought about enhanced welfare of the people. In addition it had the very important aspect of bridging the gap between the low income earners and the high income counterparts. There are very many proponents of these views in the United States who have refused to consent to the idea that inheritance taxes are harmful to the economy. In another perspective, the taxes of inheritances vary from one state to the other across the United States as a result it may be bringing out positive results in some states (economically) and states at the same time being damaging to others.

Recommendations

In order to streamline the administration of the taxes of inheritances, respective authorities in the United States should consider the option of standardizing the taxes across all states. This will lessen the administration procedures and the ultimate reduction in the cost involved in the taxes levy. According to the commissioner of taxation and Copenhagen economists, 2000, a uniform taxation policy is bound to be less costly in terms of administration. They add that such a standardized taxation system will require fewer administration units and as such the costs involved will be less.

The authorities should consider installing a highly effective system that will in the very best way possible register all the death cases including those who are executed by the state as well as in the valuation of the taxes of inheritance. This will improve the accuracy with which the taxes are levied hence increasing their productivity.

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In addition, proper measures need to be put in place to ensure that both the normal income taxes and the taxes of inheritances were not exorcised on the same property. This aspect of double taxation was very burdening to the taxpayer. The result of this bit is that it discourages investments. High interest rates are a hindrance to investments. This may slow down the economic growth rate (OECD, 2008)

Controls should also be put well in place to ensure that the evasion of taxes by some citizens in the United States was curtailed. This will ensure proper accounting of deaths and property transfers thus ensuring that every case subject to taxation was actually taxed. The idea if implemented would increase the collection of the taxes in multiple folds

Work cited

Atkinson A and J Slitgiz, the tax design structure, direct versus indirect tax. Journal of Public economics 6 55-75, 1976

Beer c, et al, Australian Households Financial Wealth. An Analyses Based On Micro Economic Data in Monetary Policy And The Economy Q2/06.Viena, 2006

Brunner j and s speck, Optimum Taxation Of Inheritances Jon Kipler University of Linz; Department Of Economics, working paper 806 2008.

Commission on Taxation and Copenhagen Economists 1978-1979 Caribbean Australian taxation office, 2000

Heer. B, Wealth Distribution And Optimal Taxation In Life Style Economies With International Transfers, university of Muninchen, Dept of economics Discussion Paper 2000.

Hans flick(ed). Taxation Law of Inheritance for the People of Republic of China, The 1999 Speech, 2006 IRS publication 950, Inheritance Taxes.

Kopczuk W and J sleemond, Dying To Save Taxes; Evidence from evidence tax Return On death elasticity; Review of Economic and Statistics (852), 256-265, New York, 2003

OECD, Taxation and Economics Growth, OECD ECO working paper 620, 2008

William. G and Benjamin. H. A Citizen’s Guide for 2008 Elections and Beyond; New Taxation and Economic Growth. Washington DC, 2007

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