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October 13, 2009
Patches, Portability, and Punting Versus an Estate Tax KISS
by David Cay Johnston

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In less than 100 days, the estate tax goes on hiatus for a year. The buzz in Washington, as well as within the trusts and estate bar, is about three possible options for Congress. I have a different idea, one I hope readers will weigh in on with letters and commentary to Tax Notes and in other publications.

The trusts and estate bar is talking about portability, with most of the focus on variations of proposals devised by Jonathan Blattmachr of Milbank Tweed and Prof. Mitchell Gans of Hofstra University. Three proposals in bills are all designed to make it more likely that the surviving spouse gets to use the first-to-die spouse's estate exemption.

As we have come to expect from Blattmachr and Gans, the concept is simple, but the execution would require changes to the law both subtle and complex. I am sure portability as proposed would also eventually create new loopholes, although it could take years for them to be created.

Others are betting that Congress will just extend the current-year rules temporarily. After all, each year Congress patches over the alternative minimum tax rules so they do not apply to 20 million or so people, mostly married couples with children and five-figure or low-six-figure earners who own their homes in areas with high state and local taxes, which is where the better-paying jobs tend to be. That patch seems not to arouse any voter ire, so why not just patch the estate tax? This approach would also come with one obvious advantage for politicians who stoke the fantasy that America taxes death. An annual vote to patch the estate tax would draw campaign contributions, a sort of voluntary tax on those who want to kill what they call the death tax.

And then there is a very small group that thinks Congress will run the clock out by doing nothing. Punting would be dangerous, especially for those among the very rich who are detested by their heirs. Oh, the novels to be written on strategies to knock off the fabulously rich grandmother or uncle — strategies as complex as a Blattmachr estate tax avoidance plan — but with the risk of life imprisonment or worse if the plan unravels.

Also, a punt by politicians would return us to an estate tax designed for a time before most Americans were told that instead of collecting a pension check each month, they had to amass assets for their golden years.

There is another approach. Let's try an estate tax KISS, as in "Keep It Simple, Stupid."

Few things vex our tax system more than the increasing complexity that enables those who can afford the best legal and accounting talent to pay less tax while making mince-meat of basic economic and legal concepts.

That portability would add complexity is clear from how many pages it took Blattmachr, Gans, and Austin Bramwell, a Milbank lawyer, to explain their idea and show model examples, all egregious examples of unfairness in concept. They show persuasively how current law treats very differently people with similar amounts of wealth based on how those assets were acquired and are titled and the degree of trust within the union.

"Estate Tax Exemption Portability: What Should the IRS Do? And What Should Planners Do in the Interim?" is 30 pages long. (Blattmachr's, Gans', and Austin's article is available at

The points Blattmachr and Gans make are all valid, but their flaw is that they start from the premise that current law is the standard to work from.

What if we start from a different premise: The way married couples hold their money is no more the government's business than how they hold each other. Once two people get a license from the state to be a couple, then no law should rend the privacy of that bond.

Let's think about how to make complying with the estate tax as minimal a chore as possible. Can we get rid of all tax forms? Or maybe reduce compliance to a single separate filing for each taxpayer, which can be a married couple filing jointly, a head of household, a single filer, or even married couples who file their income taxes separately.

Can we create an effective system that does not require any advance planning, not even a will? Can we stop discriminating between the coldly rational who can contemplate their own demise and those who are so terrified of the end they cannot bring themselves to perform even that basic act of contemplation?

How simple can we go?

For starters, how about abolishing the idea of, and the need for, a credit shelter trust? To take advantage of this year's $3.5 million exemption for the first spouse to die, one must meet with a lawyer, devise a plan, and then title assets separately. Why?

Our society treats married couples as a single economic unit. We count those who are married filing jointly as "a taxpayer." But when it comes to estate tax planning, we expect people to be unified in planning, yet separate in asset ownership to take full advantage of the law.

Instead of all that, we could just add a check-the-box feature to Form 1040. When the survivor files the tax return for the year when the spouse died, he just checks a box. It could be inserted at the top of Form 1040 on the name line without adding a line, or as a sixth category under filing status, or by modifying the qualified widower box to distinguish between first-time and ongoing status.

Checking the box would then prompt the IRS to note in the permanent file on the surviving taxpayer that when he dies, his exemption is the amount for the first spouse ($3.5 million this year) and whatever the law is for the year when the second spouse dies.

Now what if when the first spouse dies, the couple is worth $4 million, but the first to die only had assets of $500,000?

That's the wrong question. It assumes there is some social good served when the government sets rules defining benefits based on the financial relationship between couples.

And what if the IRS fails to save that detail? No matter. All the estate of the second spouse must do is provide proof of death of the first spouse and of the marriage to get the exemption for that year.

And what of the case, which will be widespread, in which the first to die had little to nothing? Indeed, what if the couple had little or nothing? Then there is no harm because it does not matter.

And what of the case in which the surviving spouse goes on to amass great wealth and dies with a fortune that is greater than the exempt sum of the year when the first of the couple died plus the exemption in the year the second died? Let's say the exemption is $3.5 million for the first spouse to go and $5 million when the second dies and the estate is worth $9 million. In that scenario, the tax would apply only to the $500,000 above the combined exemptions. And it would apply only when the second spouse dies.

Under this simplified system, no Form 706 would be required until the second spouse died. Why? Because the government does not collect until the second spouse dies, and then only if their wealth exceeds the threshold set by Congress.

This would also mean that any charitable gifts would be made at the death of the first spouse under the rules that would apply when both spouses were alive. The same rules would also apply to gifts to family and friends: tax-free below a threshold set by Congress currently $13,000, and taxable above that. That raises an issue. Should the widow or widower get to make tax-free gifts at the couples' rate of $26,000 or be limited to $13,000?

What of the step-up in basis when the first spouse dies? That existing law would be repealed. The surviving spouse would owe capital gains taxes on any assets sold for more than their basis. In this, he would be treated no differently than if both spouses were alive.

The issue here is simplicity versus letting the surviving spouse in a couple that planned and held assets in the form demanded by Congress reap gains without tax. As with unqualified executive deferrals, this violates the principle that income and tax should be matched in time.

The tradeoff in simplicity and fairness seems clear, although I especially hope readers will weigh in on this point.

Now what of a subsequent marriage? Can a widow or widower marry, outlive another spouse, and die with three exemptions?

Why not?

If the policy is that each person gets an exemption, then we should hold to that principle. The merry widow who attracts and outlives husbands three, four, or even nine can pile up exemptions, which have value only if there is money there, since no tax would be due for the 99.9 percent of Americans who die each year without enough to be subject to the estate tax.

And that one case — say the poor little rich girl of the future who marries one fortuneseeker after another and outlives them all and gets to leave, say, $50 million free of tax — so what? No law can contemplate every situation. Policy should not be made for the bizarre, but the usual. And in this strange example, the fortune hunters may want to ask themselves whether the pleasures of such a marriage would be outweighed by a proven propensity for early death of the penniless partner.

In the same vein, I would not deny Bill Gates any of the child credits or exemptions for his dependents, because the complexity of phaseouts is not worth the revenue. Better to adjust the exemption levels and tax rates to fine-tune the revenue than to muck up the code with rules that treat taxpayers differently on anything except the ancient and thus very conservative principle of progressive tax rates on economic gain.

So, readers, take this challenge. Critique this proposal in terms of how to make the law as simple as possible. Even if you favor eliminating the tax, take a hand at trying to figure out how to make compliance with a continuing estate tax as simple as possible.

And if we can come up with ways to make the estate tax truly simple, maybe two things will happen. First, Congress just might enact a simpler estate tax. Second, a lot of informed and bright minds could start working on how to do the same for the rest of the tax code.

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