Editorial Board

Look How Easy It Is to Game Estate Taxes

In a speech earlier this month, President Barack Obama reminded his audience, if it needed reminding, that the U.S. is an unequal society and becoming more so.

The top 10 percent takes home half the total income, up from a third in the late 1970s, he said. And a child born in the bottom 20 percent has less than a 1-in-20 chance of making it to the top fifth, while the chances for a child born in the upper 20 percent are a far better 2-in-3.

Curbing inequality requires an array of policies -- some to improve opportunities for the disadvantaged, and others, as the president once put it, to “spread the wealth around.” The estate tax was conceived with the second in mind. These days, it’s doing nothing of the sort.

In its current form, the estate tax requires the rich to pay a 40 percent levy on wealth they leave to their heirs, after an exemption of $5.25 million (rising to $5.34 million in 2014). That’s the theory, anyway. In practice, for the wealthiest families, the estate tax is largely optional.

As Zach Mider reports in the February issue of Bloomberg Markets magazine, since 2010, Sheldon Adelson, a casino magnate and one of the world’s richest men, has exploited a loophole to pass nearly $10 billion to family members and legally avoid at least $2.8 billion in U.S. inheritance taxes. The technique is used by hundreds of chief executive officers and bankers, and may have cost the federal government $100 billion since 2000.

The loophole in question is the grantor-retained annuity trust, or GRAT. It involves rapid churning of stocks, bonds, real estate and the like into and out of a trust, allowing any increase in asset value to pass tax-free to someone else. It isn’t the only loophole. The Tax Policy Center estimates that only 3,780 households (0.14 percent of all estates) will owe any estate taxes this year. Their average payment will be $3.8 million on estates worth $22.7 million -- an effective rate of 16.6 percent.

Keep in mind, too, that most wealth escapes tax as it accumulates. Appreciation of property, securities and art isn’t subject to capital-gains tax until the assets are sold. When they are passed along, much of this unrealized profit remains untaxed, thanks to the optional estate tax. The oft-repeated charge that estate taxes amount to double taxation is doubly wrong.

Congress ought to close the GRAT and other loopholes. And it might note that the voluntary estate tax exemplifies a wider issue: The U.S. tax code is insanely complicated. This favors the rich because, unlike ordinary taxpayers, they can afford to find loopholes amid the complexity. Simpler tax systems are fairer -- and they distort decisions less.

When President Theodore Roosevelt first proposed to tax estates in 1906, he said it was to help preserve a “measurable equality of opportunity” for future generations. That remains a worthy goal. Obama should fight harder to mend the defects that have made a mockery of Teddy’s idea.