Death and Taxes

I

BELOW the age of forty the average man has little interest in inheritance taxes, but let him become an heir or an executor and suddenly he is keenly interested in a subject of bewildering complexity. Unless he has the legal turn of mind, the more he looks into the subject the more confused he is apt to become. The intricacy of the situation is appalling.

There is no standardized inheritance tax. The District of Columbia, Florida, Alabama, and Nevada impose no inheritance taxes. Each of the other forty-five States has its own individual tax-rate, exemptions, deductions, and special methods of computation. In addition to State inheritance taxes there is the supremely effective Federal Estate Tax on all estates of over $50,000. Again we find that the Estate Tax is based upon a fundamentally different principle from the inheritance taxes of the great majority of the States.

In fact the confusion has become so marked and so costly that President Coolidge himself addressed a conference of tax officials from the different States and made a strong appeal for a common-sense revision of inheritance taxes with a view to removing the vicious features, reducing the burden of these taxes, and clarifying the entire situation. He even went so far as to suggest for consideration either that the Federal Government should step aside, abolish its Estate Tax, and leave the field to the States, or that the States should retire, let the Federal Government collect all death taxes, and apportion them among the States which would otherwise have jurisdiction.

He laid special stress on the overlapping-tax evil which is one of the glaring injustices of the present situation, and made clear the dangers of such vicious legislation by illustrating the wasting of estates by this multiple capital levy. Pointing out the tremendous burdens imposed upon the estates of our captains of business by the high brackets of the Estate Tax, simultaneously with the overlapping inheritance taxes, he sounded a warning that a continuation of such taxation would kill initiative, undermine the very foundations of business, and lead to Communism. The logic of his argument for tax reduction and simplification was indisputable. The press gave wide publicity to and approval of the President’s position. A few days later this conference of tax officials adjourned.

What has happened since? Unmistakable results of the President’s firm stand on multiple taxation and tax reduction soon began to appear in the different legislatures. On February 24, Nevada went to the extreme by passing an act which repealed her existing inheritance-tax law, this act to take effect on July 1. Bills began to crop up in other legislatures seeking to abolish similar legislation. For a short time it looked as if several States would abandon inheritance taxes. Three days ahead of Nevada, Wyoming graciously let down the bars to nonresidents on stocks of domestic corporations. In Kansas a bill was introduced to repeal the transfer tax of near relatives; in Ohio a bill to repeal the inheritance tax of that State; in New York a bill to increase the exemption to members of Class 1 from $5000 to $10,000; in Pennsylvania a proposal to amend the constitution so as to grant exemptions, and another measure to exempt the transfer of personal property within the jurisdiction of the State of a nonresident decedent. In Arizona and Delaware we find efforts to abolish the inheritance-tax laws; in Oklahoma a bill aimed at the income-tax law as well; in New Jersey an effort to amend the constitution and abolish both inheritance and income taxes. Other States have made gestures in these directions.

New York is one of the few States that met the overlapping-tax evil sensibly, with a new law. In this new law that State inserts a reciprocalexemption clause which exempts a nonresident from taxation by New York (a) if he is a resident of a State that has no inheritance tax, such as Alabama, or (b) if his State of residence extends a similar reciprocal exemption to nonresidents, as does Massachusetts.

To what degree do inheritance taxes overlap?

Speaking in general terms, the property of the nonresident which is most widely taxed is stock — shares of a corporation which may have one or more States of incorporation. If the corporation in which his stock makes him virtually a partner happens to be incorporated in several States, so much the worse for his family when the time comes to pay inheritance taxes. Each of those several States may exercise the power to exact and collect a tax on the same block of stock, and these taxes will be in addition to the tax of his home State (unless he lives in the small group which impose no inheritance tax), and in addition to the Federal Estate Tax, if he happens to leave over $50,000. The mischief of this tax upon tax upon the same bit of property is at once apparent, and the frame of mind of one who has been called upon to pay such taxes can be easily imagined.

In an estate of any size at all triple taxation is common and double taxation is the rule. Let us illustrate. Assume the estate is about $200,000. This means double taxation — tax by State of residence and Federal Estate Tax. But many of the stocks in an estate of this size will represent companies incorporated in another State. Let us say they are Michigan corporations. Then we have triple taxation as far as all the Michigan stocks are concerned — Michigan tax, home State tax, Federal Estate Tax. It is a perfect system. Collections are always good. The States are poor and need the money. They have been getting it. They hate to give it up.

II

Dropping the overlapping-tax evil, let us turn for a moment to another weak spot in the inheritance-tax situation in most of our older States — that is the exemptions.

The exemptions are the arbitrary amounts which a State says shall not be taxed. Some States insist that one exemption only can be allowed to an entire estate. Most States classify the beneficiaries into groups determined by blood relationship, and then allow a certain exemption to each member in a group or a certain exemption to each group as a whole. Here again we glimpse the amazing variety and confusion of these laws.

Because of the remarkable efficacy of inheritance taxes as income-producers for the State, the exemptions in most of our Eastern or older States are much too low and do not take into serious consideration the actual needs of the widow. For example, Delaware, which is one of the fairest States in the Union in her inheritance-tax legislation, allows a widow a munificent exemption of $3000. Imagine a widow left a small estate as her sole means of support, and the meagreness of the exemption becomes at once a hardship.

At the time this article is being written the average maximum exemption of all the States is a little under $11,000. Kansas takes the lead in her fairminded consideration of the widow, to whom she allows an exemption of $75,000, which is not even approached by any other State. The next largest exemption is $25,000, found in only two States at this time, and the next is $24,000, found in California only. From this figure we drop to $20,000, found in about five States. Thus we find the majority of exemptions below this figure, which in itself is inadequate.

If, then, we are to steer clear of confiscation and Communistic tendencies, must we not first of all give proper consideration to the widow and leave her, free from all death taxes, at least a competency which takes into account the present scale of living costs?

An unfortunate phase of the exemption situation is the exemption which has a trick of disappearing entirely, as is the case in Massachusetts, New York, and a few other States. For instance, Massachusetts allows a widow an exemption of $10,000. If, however, the husband has left her over $10,000, the exemption disappears and the tax attaches to the entire distributive share with the proviso that the tax may not reduce her portion below $10,000. When you add a disappearing act to an exemption that is inadequate at the start, injustice and sometimes hardship result.

Only the other day an executor told me of settling an estate the chief beneficiary of which was a gentle old woman who was left $12,000 as her sole means of support. Death taxes took $600 out of her principal. Without question this estate had been left in bad order, else the taxes would not have eaten so large a hole in the principal. But this does not alter the fact that this hardship has been inflicted upon a helpless old woman, and legally inflicted by presumably deliberate legislation. While there is much hue and cry about the high brackets of the Estate Tax, which falls most heavily upon the rich, should not our legislators first of all see to it that they have not taken away the widow’s mite?

More recently a fellow tax-specialist called to my attention a small estate of $20,000 in which one of the heirs paid an inheritance tax of some $1500 to the State of Pennsylvania. Here we have a State which at this writing grants no exemptions to individuals.¹ This heavy tax was due to the fact that this particular heir was a cousin, hence subject to the ten-per-cent rate on the Pennsylvania property, which amounted to $15,000. Here again we find a situation where ignorance of the inheritance-tax laws or neglect of the donor to rearrange the estate properly cost the beneficiary an unnecessarily heavy tax.

The time limit is a third factor which too often causes hardships in the settling of estates. Vermont, whose inheritance-tax legislation is among the best of all our States, is broad-minded in allowing two years. The average time allowed for settlement, however, is but twelve months, and some States impose a penalty-interest charge if the tax remains unpaid at the end of six.

To put it another way, the average executor has but twelve months to settle up an estate and get all the death taxes paid. Otherwise he faces penaltyinterest charges or suits to collect these taxes. He is further spurred to prompt settlement in certain States by a discount for cash, usually about five per cent for payment within six months of death.

More often than not the cash is not available. In examining the actual court-records covering the estates of men of large means it is surprising to note that the cash on hand in the estate is usually from a tenth to a twentieth of the amount representing debts and taxes which must be paid before the estate can be distributed. Take the case of G. M. Rothschild, who left an estate of a little less than six millions. His cash was found to be less than three hundred dollars, while taxes amounted to considerably over a million, to say nothing of debts. Nothing strange or discreditable about this. The man of large interests has his funds tied up in his business. He likes to keep his money at work, and frequently he has to tie it up in real estate or close corporations to get the return he demands. In his zest for conquest, however, he forgets his family and the price which they will have to pay through their executor in order to raise the cash within the time limit.

Where an estate is left largely in real estate, property which should not be pushed hurriedly into a market, the executor is forced to sell at once the best securities or the cream of the estate in order to raise the cash on time. If the estate should happen to be wholly real estate it is probable that the executor would have to borrow by mortgaging the property to get the cash. In either case the forced sale of securities or real estate depresses the market as a rule, and prices are accepted which may be far below the price which could have been obtained under fairer conditions.

It is but natural that in many cases Liberty bonds, Municipals, and the choicest investment stocks are thrown overboard regardless of the position of the market. When the estate comes to be distributed the heirs find themselves in possession of unlisted securities having narrow markets, real estate and other property not readily convertible. The cream is gone. Uncle Sam and the various States get it because this is the one tax they are sure of collecting on time.

III

One of the sorest spots in the entire inheritance-tax situation is the burden placed upon life insurance.

Over eighty per cent of all that men leave to their families is life insurance. Thus, when we consider how large an item life insurance is in the average estate, we see at a glance what a tempting field it offers to the tax-collector. Let us first touch upon the Estate Tax in this respect.

The Federal Estate Tax gives an exemption of $50,000 and further exempts $40,000 of insurance to a named beneficiary. In other words, a man may leave $50,000 worth of stocks, bonds, real estate, or other property, and $40,000 of life insurance to his wife, and his family will not have to pay an Estate Tax because of these exemptions. Any insurance over the $40,000 becomes subject to tax.

Here we have a point that has been subject to costly legal battles which will continue until it is cleared up. In the famous Frick case, which has recently been decided in favor of the Frick Estate, the lower court held that this tax upon life insurance was unconstitutional. The case was carried to the Supreme Court, where it was hoped the question would be settled once for all. The Supreme Court ruled that the tax should not have been imposed upon the Frick insurance because this policy had become payable prior to the act of Congress imposing this tax; that this act could not be retroactive, and hence this tax should be refunded to the estate. The Supreme Court did not discuss or rule upon the question of the constitutionality of this tax upon insurance, deeming that it was immaterial. Thus the situation remains for the most part unchanged, in that insurance which has or may become a claim since Congress passed this act in 1919 is taxable above the $40,000 exemption.

When we realize in how many cases life insurance constitutes the sole means of support for a family suddenly left without a provider it would seem that the Federal Government should raise the exemption on insurance to at least $100,000 or exempt it entirely when made out to a named beneficiary.

In addition to the Federal Government we find five States which at this writing tax life insurance under certain conditions. Arkansas taxes except when the insurance is payable to the widow or a direct ascendant or descendant. Montana taxes all insurance over $50,000, while Mississippi taxes all over $20,000. In Tennessee, insurance payable to beneficiaries who are strangers or collaterals is taxable, while Wisconsin has the worst record of all, in that she taxes all insurance with no consideration of the hardship which such taxation may impose. The above constitute the exceptions to the general rule that insurance to a named beneficiary is usually exempt. This general rule should be the universal rule, because there is small excuse for penalizing a man’s family for the one unselfish act of self-denial and thrift exercised in order that he may keep his family from want and suffering if he is taken away before he has been able to provide a competence. Such taxation is difficult to understand, almost impossible to explain on any grounds of reason or justice.

IV

Here then we have four outstanding sore spots in the inheritance-tax situation: (a) overlapping taxes, (b) meagre exemptions, (c) executor being forced to act too quickly, and (d) taxation of life insurance. Why do these sore spots continue to exist?

Ignorance is the only answer.

You and your neighbor don’t know half as much as you ought to know about inheritance taxes because you think you will never have to pay them. Your family may pay the price for your indifference. It is human nature to postpone doing anything that pertains to death. We do not like to think about it. It is so easy to put it off another day. We are indifferent because we do not know how much our indifference may cost our wives and children. If you knew that a certain block of stock you were rather partial to would bring a death tax of just so many hundred or thousand dollars and that you could save your wife that tax by switching over into another stock just as good in every way, or by buying a certain bond, would you not make that change in short order?

It is very questionable if many of us would wish to give up our associations and friends, pull up stakes, and trek to a tax-exempt State like Alabama just to dodge the bulk of inheritance taxes. Most of us think too much of the home State to want to do that. It is not necessary. Moreover, the taking-up of residence in a tax-exempt State does not dodge the Federal Estate Tax, which is likely to remain, in modified form, for just this reason. If this tax should be removed there would then be spots which would offer total exemption from death taxes, and such spots might become asylums for taxdodgers. Uncle Sam is not keen to establish any such asylums. He does not believe in encouraging tax-dodging.

To trek to the tax-exempt State is not necessary, because with a little care and forethought a man can arrange his estate so that his family will have to pay no more than the legal minimum. And a little more forethought will see to it that cash, Liberty bonds, Municipals, or insurance are provided to take care of these minimum taxes.

Absurd or seemingly impossible situations have arisen more than once because of ignorance of inheritance taxes. Not long ago a man of wealth arranged in his will that one of his sons should pay all the death taxes of the estate. These taxes amounted to a sum so far beyond this son’s share that he was thousands of dollars in debt in carrying out the terms of the will.

Speaking of the injustice of the present inheritance-tax situation, a business man wrote to me the other day and said, ‘The situation is so bad that it certainly can’t become worse and must improve.’ If this man were to die now his family would have to pay handsomely in multiple taxes because of his indifference.

Secretary Mellon has termed such taxation ‘economic suicide,’ because it encourages the spending of capital for current expenses. One of our foremost financial dailies gives a more graphic description, calling it the ‘eating-up of seed corn.’ Every man owes it to his family to familiarize himself at least with the inheritance taxes of his State of residence and should see to it that his will and his investments are made with due regard to the exemptions which are permitted. He should get the family attorney to advise him as to whether his will has imposed terms which will inflict a penalty on any one member of the family. He should acquaint himself in a general way with the States which are known as ‘favorable’ from an inheritance-tax investment standpoint, and when he buys stocks he should stick pretty closely to those States and his home State. He should know that the ownership of a single share of stock in a certain State may make taxable certain coupon bonds in his estate that would otherwise be tax-exempt.

He should be quick to see t he advantage of having his wife own outright a goodly portion of his estate, and he should remember that the Federal Government imposes a gift tax on all gifts totaling over $50,000 in any one year. A good man of my acquaintance has already paid two different inheritance taxes on property which he had given to former wives. He has been a ‘good sport’ and has preferred to do this rather than run the risk of having his widow pay a very much heavier tax.

V

My experience in examining estates from the inheritance-tax standpoint points toward certain tendencies. It would hardly be safe to draw conclusions, so varied are the combinations.

If a man of large affairs is a financial man and has been largely concerned with the handling of securities rather than the conduct of business or realestate operations, one is apt to find that his estate is in a better position to meet inheritance taxes promptly than the average estate and with less shrinkage due to forced sales.

If, on the other hand, the client is wholly absorbed in one business and cares nothing for the market or for real estate, one is apt to find his estate carrying a large proportion of shares of a close corporation, which cannot be quickly liquidated or the sale of which may disturb the control of the business. In such a case we have a fairly typical instance where the executor may be forced to make sacrifice sales in order to raise the cash for the payment of taxes.

Another type is the young man who has accumulated perhaps half a million through a touch of inventive genius. He carefully divides his estate with his wife and in her portion he leaves most of the bonds and the more conservative stocks. In his share we find bonds and a wide range of stocks. His share, because of the variety and proportion of stocks, bears the heavier tax, which the wife would have to pay if he should die first. The diversification is excellent. It gives just so many more States the opportunity to impose their taxes. Thus diversification means one thing from the inheritance standpoint and another thing from the investment standpoint. Both should be weighed, because at times the inheritance tax can be disregarded in favor of the investment return.

In the estate of the man who has a fondness for real estate we may find a freedom from multiple taxation, but we are also apt to find surprisingly little cash or easily liquidated securities. Here again we find a case where the executor may have difficulty in raising the cash for the taxes, and in meeting this difficulty he may be forced to make sacrifices which would make multiple taxation itself blush. Doctors, lawyers, and ministers represent groups on which inheritance taxes are apt to fall heavily. You may think it strange that I have included lawyers in this grouping. But a lawyer who is at the same time a successful investor and a specialist in inheritance taxes is the rare exception, not the rule. Each of these professional groups is so concerned with professional thought that it has little time for the study of investments. For this reason professional men quite often accumulate a wide variety of securities of doubtful value, or, if not of doubtful value, of extremely wide diversification. We have already noted the fact that diversification in ownership of stocks may mean a broadside of inheritance taxes.

One of the first estates which came to me for examination was that of a minister. Naturally an estate of modest proportions, the tax itself was small. But the estate was involved in some seventeen different States, calling for either taxes or waivers from each. A waiver is the document issued by the proper State official permitting the transfer of stock, and must be obtained before the stock of a decedent may be sold. The annoyance, delay, and expense in settling a small estate so involved would have been out of all proportion to the value of the property. Furthermore, the exemptions of the State of residence were such that a simple rearrangement ensured exemption for both wife and children.

‘Eating up seed corn’ is bad business. It will continue just as long as we are content to have it so. But more time is required to change laws than to change investments, and every estateowner should look to his holdings as a first step in insuring his heirs against unnecessary and unjust losses through inheritance taxation.

1. Since this article was written, Pennsylvania has passed a law granting reciprocal exemptions to nonresidents living in States which grant the same privilege to residents of Pennsylvania.↩