The Twilight Land of Taxation
I
THEODORE ROOSEVELT, with a typically happy and colorful expression, described the interrelationship between Federal and State Government on commerce and taxation as ‘Twilight Land.’ Admitting the aptness of his description as far as death taxes arc concerned, of late years a bewildering fog has settled upon the Twilight Land, becoming most dense in the year 1924.
Double taxation flourishes here in the United States as perhaps in no other country. Why? At first glance American indifference or good nature may appear to be the answer; but the underlying reason for this indifference is a lack of knowledge of what has actually been going on. Let the American citizen once grasp the facts of the situation and he will inform his representatives in both State and Federal Governments in no uncertain terms that the sore spots in the system of taxation must be cauterized.
It is hardly reasonable to assume that the vicious overlappingor multipletax evil sprang into being through the deliberate intent of our lawmakers. The fog that shrouds the Twilight Land lies thickest on the situation between States. Here again the present jumble is due to ignorance on the part of our offending lawmakers as to death-tax laws in surrounding or competing States, combined with a wholly human desire to get the money first and revise the laws later. I say ‘ignorance,’ because it is already evident, as the spotlight of publicity is being turned upon certain ill-advised and shortsighted phases of this taxation, that these mistakes would not have been legislated into existence if our legislators had quietly stepped back and taken a longrange view of the entire situation.
Until comparatively recently each State has been too much concerned with her own death-tax laws and has ignored those of her neighbors, with the result that not only her neighbor’s citizens, but her own as well, have suffered. In far too many cases States have enacted death taxes hastily without first carefully considering the economic effects.
For instance, let me quote a portion of the last paragraph of the inheritancetax law of a State I shall not name, as it is not a solitary offender: '... owing to . . . the further fact that large sums of money due the State as taxes are not being collected, and the fact that the revenue and school funds of this State are badly in need of additional revenue, creates an emergency and an imperative public necessity requiring the suspension of the constitutional rule that all bills be read in each House on three several days, and that this Act take effect and be in force from and after its passage; and it is so enacted.’
A still further tribute to the efficacy of the death tax as an unfailing source of revenue is another clause commonly found in our State inheritance-tax laws. It is usually headed ‘Constitutionality.’ I do not need to quote. In effect it says: ‘ If any part of this law is found to be unconstitutional the rest of the law will continue to function. We must keep the machine rolling and cannot stop for trifles such as punctures or blowouts.’ It is all very well to keep the tax machine rolling. The expenses of governing the people never stop; but it is the very punctures which have occurred that have focused the eyes of the people upon the evils of taxation.
In estates of over $50,000, double taxation became common in 1916 when the Federal Estate Tax was enacted as an excise tax under the pressure of the World War. In the Revenue Act of 1916 the highest bracket was a ten-percent levy. In March 1917, this Act was amended and the entire tax slightly increased with the highest bracket fixed at 15 per cent. In October of the same year there was a further increase of the entire tax, and in the highest bracket 25 per cent was reached. Early in 1919 the lower brackets were slightly reduced, but in 1924, nearly six years after the World War had come to an end, Congress again tampered with what was originally a war measure by raising the entire tax, with the exception of the two lowest brackets. This Congress raised the highest bracket from 25 per cent to 40 per cent!
Thus, from 1916 on, we have had double taxation as a common occurrence in estates not covered by the $50,000 Federal exemption: that is, taxation by the Federal Government and taxation by the State of residence. With characteristically clear vision President Coolidge long ago recognized the mischief that was being worked by the high brackets of the Federal Estate Tax, as well as the vicious tendencies of this multiple tax. He has voiced his convictions, which are based upon the soundest of economic grounds, has told the people that it was clearly the business of the States to set their houses in order, and is himself bending every effort toward a reduction of the Estate Tax.
From an economic if not from a social standpoint, it seems hardly desirable that the Federal Estate Tax should be entirely abolished, because such abolishment would in effect establish certain States as almost perfect asylums for men of large means who desired to dodge all death taxes. Such a situation might not be wholesome and might to some extent handicap many States which do not care to go to the extreme of abolishing their inheritance taxes.
On the other hand, it is felt that a material reduction of the Federal Estate Tax is not only most desirable, but is wholly practical, for the reason that the total amount raised by the Estate Tax is so small a fraction of the total revenue raised by our Government that the reduction or abolishment of this tax would do little to disturb the balance of the Federal revenue system. Mr. David E. Finley states that in 1924 the Estate Tax contributed but 2½ per cent of the total revenue received by the Government from all sources.
Still another factor to make confusion worse confounded is the Gift Tax included in the Revenue Act of 1924. The purpose of this tax was to exact a Federal levy from the transfer of property that might escape the Estate Tax. In effect, the Revenue Act of 1924 is a double-barreled shotgun; one barrel is loaded for gifts from the living, the other for gifts from the dead, and both are always aimed at the capitalist.
In the Gift Tax we have a law the constitutionality of which may well be questioned. In application, the Gift Tax may easily conflict with the Income Tax, creating still another form of double taxation quite without reason or justification. It is generally understood that the Administration has small sympathy with the Gift Tax because it is so ill-grounded from both the legal and the economic standpoints. In the main it closely resembles the Estate Tax, both as to rates and exemptions.
Beyond question here is an evil that must be stamped out. Overlapping, conflicting, communistic, it is a law so unjust, so ill-conceived, as to invite repudiation by evasion. If our next Congress can read the handwriting so clearly on the wall, it will waste no time in abolishing the Gift Tax. It should be evident that much more of the wealth of our capitalists is needed in the channels of commerce and industry than is now available. Our legislators might recall with profit Abraham Lincoln’s homely saying to the effect that honey is more persuasive than vinegar.
When Congress convenes in December we may expect to see the President’s tax-reduction programme receiving early consideration. The Estate Tax is likely to be the subject of spirited debate. The States representing our greatest wealth may vote for the abolishment of this tax, using the doubletaxation argument. Much of the South and probably the West may be solidly against this. The argument may be that the heavy surtaxes of the Federal Income Tax have driven the capitalist into a wholesale investment in taxexempt municipals. On this basis the proponents of the Estate Tax may say that, inasmuch as the man of large affairs has successfully dodged heavy income-taxes during his lifetime, it is equitable to compensate the Federal Government by taking a portion of his estate at his death before it shall pass to his heirs.
Owing to the complexity of the State situation and the lively sense of the sovereignty of States’ rights, there is little chance that a workable agreement will be made between the States and the Federal Government permitting the exclusive collection of death taxes by the Government and a subsequent apportionment between the States, d here is still less likelihood that the States as a group will surrender to the Federal Government without condition this fertile field of taxation. Under these circumstances the most natural solution would be the reduction of the Federal Estate Tax to a point where it will not be an excessive burden.
For some nine years double taxation has been common. As a matter of loyalty to the home State and to the United States the tax to the State of residence and to the Federal Government is paid without overmuch grumbling. It is when the triple tax or the multiple tax, with all its injustice, appears that protests arise. This evil is bound to be wiped from the slate. It is too unsound, too unjust to endure. But it will not pass at once. Certain States will be slow to relinquish their claims. It will take time.
At the moment this article is being written, New York, Pennsylvania, and Connecticut have recently enacted, and Massachusetts has broadened, reciprocal-exemption legislation. Without using the strictly legal definition, I may perhaps crudely describe the reciprocal-exemption provision as follows. Massachusetts says in effect to New York: ‘If you will agree not to tax a Massachusetts resident on the securities he owns representing New York corporations, I will reciprocate this courtesy by agreeing not to tax the heirs of a New York resident on coming into possession of securities representing his holdings in Massachusetts corporations.’
To illustrate: Jones, a resident of Massachusetts, dies leaving his wife, among other property, about $20,000 in stock of the American Telephone and Telegraph Company, a New York corporation. Under the old laws this would have been subject to at least a double tax, by Massachusetts as the State of residence, and by New York as the State of incorporation — two taxes on the same block of stock. Under the reciprocal-exemption provision New York exempts this stock, as far as she is concerned, in favor of Massachusetts, or other States that extend reciprocal exemption under similar circumstances to her. This is a decided step in advance.
But while some States, such as Nevada, have gone to the extreme by abolishing death taxes, and while some others are talking about doing this, signs are not lacking that so simple and effective a measure for the removal of the overlapping-tax evil may meet discouraging entanglements in the Twilight Land of Taxation. I shall quote from a comparatively recent ruling of the Wisconsin Tax Commission a paragraph that clearly illustrates the logic of its position in opposing reciprocal exemption with New York: —
‘It is scarcely a frank proposal to ask this or any Western State to exempt stocks of domestic corporations left by decedents of New York, in consideration for exemption by New York of stocks of corporations of that State left by resident decedents of this State. There are several important, railroad corporations, as well as many other industrial corporations of this State, the stocks of which are held largely if not chiefly in New York City. But there are probably very few stocks of New York corporations held by residents of this State. Does it not seem like a one-sided proposition to suggest reciprocity under the existing conditions?’
The fog will not be dispelled by the reciprocal-exemption clause alone. Certain States may quite reasonably refuse to adopt it. We may have to look to other measures as well as this for the extermination of the overlapping tax.
To argue that the spread of the reciprocal-exemption privilege will be smooth and swift, and that the overlapping-tax evil will quickly disappear into the night, is to say to one’s self: ‘All is well. My family will not be burdened with the multiple tax because that will be abolished before I die.’ No man knows when his time will come. You may be called to-morrow. The overlapping tax is with us to-day; we have no conclusive evidence that it will not be here to-morrow. To procrastinate putting one’s estate in order is simply to invite that degree of confiscation which the present death-tax laws have legalized. Without action on your part your family faces the very certain possibility of having to settle a debt of unnecessary proportions.
In the Atlantic for September, I outlined four serious situations in the Twilight Land of Taxation. There is still another, affecting all estates large enough to be reached by the Estate Tax; and that is the double appraisal.
Aaron Smith dies leaving an estate of $200,000, which at this writing — excepting four jurisdictions — will be subject to death taxes by both his State of residence and the Federal Government. Before Smith’s heirs can pay these taxes there must be a thorough appraisal of all Smith’s possessions, as an appraisal is essential to the determination of the tax. Right here we have twilight, if not darkness. The State of residence makes an appraisal for the purpose of fixing the amount of the State tax. The Federal Government makes an independent appraisal to determine the Estate Tax. To a greater or less degree each ignores the other and goes its own way. The exception occurs when there are found in the estate certain valuable works of art or rare antiques, or something of a nature that requires the services of a highly skilled specialist to fix the value. In such a case an acknowledged expert in his line is engaged, and his report is quite generally given weight if not accepted in toto by both State and Federal appraisers. With this minor exception, Aaron Smith’s family subject themselves to the annoyance of at least two appraisals.
Sometimes before the executor has completed his work the Federal authorities may find that there has been overpayment or underpayment of the tax. Another appraisal is at once necessary to check up on this point.
Without considering the feelings of the family at such a time, can we find any logical apology, any economic justification for such a needless duplication of work of a somewhat specialized nature? It is a glaring example of governmental inefficiency in a comparatively simple matter.
What is to prevent the Federal Government and the States from agreeing to appoint one appraiser for each State? Then let the State appraiser and the Federal appraiser between themselves choose a third disinterested member and there would be a board of three, which if wisely chosen should be able to function for both State and Federal Government and thus remove the burden of the double appraisal.
II
The facts must be faced. Send to your State capitol and ask for a pamphlet containing the inheritance-, succession-, or death-tax laws of your State of residence. Almost all the States have a booklet containing these laws and are glad to have their citizens acquaint themselves with them. Read the death-tax laws through, slowly. At times you may get lost in legal phraseology, but you will get the general drift and the gist of it.
Generally in the first few paragraphs you will find either a table or the percentages by which the tax is estimated. Where a printed table is not given, you can quickly make your own. Study to understand the exemptions. Know the exemption that your wife or husband may have, and what is allowed to children, parents, or other relatives you may wish to remember. A knowledge of these exemptions is of first importance in helping you to set your estate in order.
Most States have something quite definite to say on ‘contemplation of death.’ Several States say that if a gift is made within two years of death that gift shall be deemed to have been made in contemplation of death, and the burden of proof is thrown upon the recipient to show that the gift was not made in contemplation of death and is therefore nontaxable. Wisconsin seems to go to an extreme on this point in that she deems that a gift of a material part of an estate made within six years of death shall be construed as having been made in contemplation of death.
Many a State gives total exemption to gifts to charitable, religious, educational, or other institutions that are incorporated within the State and operated for the public good. But few are the States that exempt such gifts made to these institutions without the State of residence. Not long ago a generous Westerner died, leaving a large bequest to the Smithsonian Institution in Washington. His State of residence taxed this gift in full, simply because it went without the State.
The Indianapolis Star is credited with the following significant newsitem. ‘Double tax may cut bequest to University. De Pauw University may receive not more than 57.6 per cent of the $2,300,000 bequests provided in the will of Edward Rector, prominent attorney of Chicago. The remaining 42.4 per cent will be assessed against the estate by the Illinois and Michigan taxing authorities. It is understood that the greater part of the estate comprised stock in the Burroughs Adding Machine Company, a Michigan corporation. If this is correct, then the inheritance tax will be duplicated in both States.’
Many States with provincial shortsightedness have gone to such lengths in order to keep the money within the State.
I can best picture the cash savings to the heirs through the judicious use of the gift method by citing actual figures. In one estate that came to me for analysis there was a possible saving of $30,500 on each of several blocks of $100,000 given away, and in this case the Gift Tax was included. In other words, by wisely giving this $100,000 the donor could save his family a tax amounting to $30,500.
Turning back to the booklet containing your State death taxes, there is another point that is important for you to ascertain. Find out how long a time your executor is allowed in which to pay the State tax. Know whether he must complete his work within six months, a year, or two years. See if your State offers a reward in the form of a five-per-cent discount for cash within six months. If there is a discount available, see to it that your executor has at least a fighting chance to win that discount for your family. Give him elbow-room, and cash to work with.
If any of your property, either cash in banks, securities, or real estate, is held jointly by you and your wife, glance again through the laws and see what your State says about joint estates. It may not say exactly what you thought it would. It is well to know on what basis your wife may be taxed on a joint estate.
The next time you go to your bank step into the safety-deposit vault and see the manager of that department. Ask him to show you a box bearing the death seal. Find out about how long a time elapses before the death seal is broken so that the box may be opened by the executor or administrator. Consider for a moment w hat would happen if that seal were now upon your box; would your w ife be seriously inconvenienced by not having access to certain documents in that box — life-insurance policies, for instance?
In many cases life insurance is the quickest, surest means that the husband has provided for supplying his wife with ready cash for immediate needs. Life-insurance policies need not and should not be left in such a way as to fall under the death seal.
Real estate is taxed by the State of its location. Thus, if you have large holdings in other States, it may be advisable to glance at the death taxes of the States involved and acquaint yourself in a general way wit h the treatment that they accord to the nonresident. It goes without saying that, in estates large enough to come under the Federal Estate Tax, real estate, like other forms of property, may become subject to the double tax,
III
Perhaps the most interesting phase of the situation is reached when we come to the subject of investments such as stocks, bonds, mortgages, notes, and so forth, because quite often desirability from the investment standpoint is diametrically opposed to desirability from the inheritance standpoint. All the securities of the United States Steel Corporation are popular with investors. We have here, however, a New Jersey Corporation. At this writing, if the stock of this company is owned in considerable blocks by a resident of any other State, and if the estate is large enough to come under the Federal Estate Tax, triple taxation is likely to attach itself to this stock.
United Shoe Machinery, Studebaker, United Fruit, American Smelting, American Can, and scores of other prominent stocks desirable either from the speculative or from the investment standpoint, and sometimes desirable from both, are at once questionable, often objectionable, from the deathtax standpoint. Years of investment experience have driven home the importance of giving most careful consideration to the investment standing of securities, because in this may lie the strength or vulnerability of the entire estate.
It does not take a very high order of intelligence to say, ‘Sell everything in this list of States and reinvest in this list of States.’ Fortunately the thoughtful investor invariably balks when such a prescription is handed out. He finds, perhaps, that his choicest stocks are banned, or that he must sell practically everything and reinvest in securities with which he is totally unfamiliar.
A rather striking example of the conflict between the investment standpoint and the inheritance standpoint came to my attention some months ago. This was the estate of a woman keenly interested in death taxes in behalf of two daughters. Here I found a most interesting situation. Over half of her estate was subject to the triple tax under existing conditions, and in this same half lay the choicest securities of her entire estate. These were securities that a woman ought to hold. There was no reasonable justification for me to advise this woman to throw these securities overboard if I could work out a plan which would reduce or compensate for the triple tax without disturbing the gilt-edged securities. This I was fortunately able to do.
I do not believe that ten per cent of our investors know in dollars the approximate amount that their families must pay in death taxes, probably within a year of their death. I attribute this inaction, amazing to one in possession of the facts, to four major reasons.
First, there is a widespread belief that putting one’s estate in order must mean a wholesale upsetting of a man’s investment programme. I have already stated that the sacrifice of choice investments is not always essential. Quite generally it can be avoided.
Secondly, there is much unsound optimism. A feeling that death taxes will soon pass is ill-grounded. Inheritance taxes have existed since about 600 B.C. They are such a supremely effective means for supporting State government that there is small likelihood of their being totally abolished.
Thirdly, there is the inevitable procrastination. Many investors intend to have their estates put in order and their taxes determined. They put it off till to-morrow because it is such an easy thing to postpone. They may not know where to turn for service of so specialized a nature. Just as neglecting to make a will may result in an unfortunate division of property, neglect to determine death taxes is likely to saddle a family with certain totally unnecessary expenses.
And finally, there is selfishness. Sometimes a man takes the attitude that, since he will not have to pay his own death taxes, he will let someone else worry about them. He ignores the fact that the analysis of the specialist will quite generally supply plans that will enable him to increase the value of the estate he may leave. To the credit of the investor let me add that I believe that this reason is rarely predominant.
It has been my experience that if an investor is fairly in possession of the facts, if he knows that these taxes are a reality and not a will-o’-the-wisp, if he sees that by a small expenditure he can in all probability leave his family a few hundreds or perhaps thousands of dollars more than he could by doing nothing, and if he understands that the putting of his estate in order need not have volcanic effects upon his investments, he is ready at once to have this work done. He knows that it is an unselfish task; he sees just how the family will benefit.
IV
Turning back to the subject of unsound optimism for a moment, let us examine the facts. Let us first assume that some men having modest estates believe they will leave so little that death taxes and expenses will be too insignificant an item to consider at this time. Is their position well taken?
In personally examining actual court records of estates I find facts that are surprising though entirely logical. In a group of small estates I find that it is not extraordinary for death taxes, administration expenses, and debts to consume from 10 to over 15 per cent of the estate. In justice to death taxes it should be said that the above shrinkage must not be laid wholly at the door of the tax-collector. Without doubt certain of these estates were in bad order, but aside from this, debts and other death expenses must have been excessive in proportion to the size of the estate.
In estates of people in comfortable circumstances I find that the shrinkage commonly runs between 7 and 10 per cent. Of course the man of large affairs who counts his property value by the millions experiences a materially larger shrinkage than this because the higher brackets of the Federal Estate Tax make large and rapid inroads into his accumulations.
To say that the capitalist suffers the most from death taxes and charges is not strictly true. He does suffer the most in dollars and cents, but the small estate may and offen does experience a greater percentage of shrinkage, and here you find that the percentage hurts. A ten-per-cent depletion in an estate of $10,000 may be a grave matter.
For the man of comfortable or of modest means to take the ground that the situation in the Twilight Land of Taxation is such as to justify a donothing attitude as regards his own affairs is to run the risk of handicapping his immediate family or heirs to an extent that would never be countenanced by the financier. The latter quite naturally is accustomed to giving a considerable portion of his time and thought to the care and accumulation of his estate. He is in close touch with tax specialists in every field. He has made it his business to get these tax facts and figures beforehand, and he has prepared his estate to meet these debts well within the time limits imposed. He has seen to it that no needless multiple tax has been overlooked and that his heirs will receive the legal maximum of his estate.
The financier roughly pictures his estate as a huge uncut pie. At his death he knows that two large slices, perhaps several more, must be cut and served before his family may enjoy a morsel. His State of residence and the Federal Government will each take generous slices. Other States may follow suit before it is the family’s turn to be served, and administration expenses will consume a further portion. A very material part of the pie will be gone before the family is called to the table. Is there no way by which he can compensate for this shrinkage, or must his family remain the poorer by the amount of these taxes?
It all depends upon the man — whether he is in good physical condition, and whether he wants to arrange for the payment of these debts in advance.
As the situation in the Twilight Land of Taxation has grown more jumbled and befogged, the practice of making partial payments and of creating something in the nature of a sinking fund to take care of all death debts has become more and more prevalent. This is something that the utterly selfish man will not do. It is nothing more or less than arranging to pay these debts — which will be his family’s, not his own — on what I may roughly term an installment basis, figured upon the number of years the man may be expected to live. If he is not in good physical condition he must make his deposits at a premium, or he may perhaps be totally debarred from this opportunity to recompense his family for the debts that they must meet.
He must be in good physical condition because this funding of all death charges can be accomplished by just one means, and that is life insurance, taken out for this specific purpose. One of the material factors in the extraordinary progress of the life-insurance business in the past few years has been the awakening of our investors to the fact that this is the only way in which a family can be compensated for the debts that death incurs. To use a mechanical term, life insurance used in this connection is automatic. The event that incurs these many debts of itself makes the insurance policy a claim and provides for their prompt discharge.
Excepting five States (which tax under certain conditions), life insurance to a named beneficiary is totally exempt, up to $40,000. Above this figure the Federal Estate Tax comes into effect. Thus, outside of five States, life insurance amounting to $40,000 or less offers the means of securing an estate exempt from death taxes. Life insurance amounting to more than $50,000 offers the means of providing a family with the only estate that will be subject to but one death tax, that being the Estate Tax. At this writing an estate of over $50,000, other than fife insurance, becomes generally subject to taxation by both the Federal Government and the State of residence. The present exceptions to this general rule are the four jurisdictions having no legacy taxes.
There is one, and to my knowledge only one, estate that is 100 per cent exempt from all death taxes, no mat ter how large the estate; yet, strange to say, it is comparatively little known. This estate can be provided wherever the wife has independent means to which the husband has not contributed. The wife, with her own independent means, insures her husband’s life, naming herself as beneficiary. The amount of the insurance is limited only by her financial ability to make the necessary deposits. At her husband’s death the proceeds of such insurance become hers, absolutely tax-free, for this reason: death taxes are a tax upon the right to receive, a tax upon the transfer of property; in this case there is no transfer, for the wife is merely receiving her own property back again, and hence no death tax is possible.
Only a few days ago a chronic invalid in fair financial circumstances asked me this question: ‘Is n’t there some way by which I can provide for my death taxes so that my estate will not be depleted?’ I had to say ‘No.’ I told him that cash, Liberty bonds, and municipals were his best means of providing for the taxes, and that because of his physical condition no means was available to him to compensate his family for those certain debts. Here is a case where the man has looked ahead, desires to pay these debts for his family, and is financially able to do so, but is physically disqualified.
An interesting example of the value of life insurance in reducing death taxes came to light as I was studying probate records. In an estate of less than $60,000 I was puzzled to account for so small a legacy tax as $169. I turned to the inventory and found the answer. A life-insurance policy for $20,000 was, of course, tax-exempt in Massachusetts. This left an estate of about $39,000, which, with a wise wording of the will, left a comparatively small balance taxable.
It. is not the purpose of this article to overdraw the picture and paint, the situation in the Twilight Land of Taxation in untrue colors. It is not the total foreign and multiple taxes which a badly ordered estate must pay that is a serious problem — it is the principle that is wrong. Apart from the expense of the multiple taxes, the executor must bear with the annoyance and delay caused by these minor items. Several Western States require local administration in settling the estates of nonresidents. Too often the local administrator’s fee is far out of proportion to the value of the service rendered.
A simple way in which to save your family the expense and delay of a seemingly small detail is to have as many copies of your will drawn off as there are States in which your property is involved. They may be needed.
While the overlapping of tax on tax as between States may some day pass, that day is yet to come. There seems to be less likelihood that the double tax between the majority of our States and the Federal Government will immediately disappear, although we may reasonably hope that the rate of taxation will soon be materially reduced. Under such circumstances it becomes a matter of common prudence to acquaint one’s self with the facts concerning one’s estate and to make immediate provision so that the family may not be put to the extremity of forced sales of property in order to secure the cash that the taxes and the usual death-expenses will require.