Testimony of Frank Clemente, Executive Director, Americans for Tax Fairness Public Hearing on Internal Revenue Service Rule on Estate, Gift, and Generation-skipping Transfer Taxes: Restrictions on Liquidation of an Interest (REG-163113-02)

December 1, 2016

Americans for Tax Fairness is a diverse coalition of 425 national and state endorsing organizations with a combined membership in the tens of millions.

I’m here in part to deliver a letter in favor of the valuation discount rule signed by 45 national organizations, which is an addendum to this testimony. The list of signers is diverse, ranging from think tanks to unions to religious groups to public interest organizations.

Americans for Tax Fairness also secured support for this rule from 18,930 of our members and supporters who sent comments to the Treasury Department urging that the rule be finalized. The letter of transmission used to place those comments into the regulatory record is also attached.

We are concerned that the wealthy and many large corporations avoid paying their fair share of federal taxes by taking advantage of sophisticated interpretations of the law and regulatory guidance. That is why we strongly support Treasury moving to address these instances of tax avoidance wherever possible and appropriate. The present Treasury action is just such a situation and represents a highly appropriate action on Treasury’s part to protect the tax base and enforce the intent of the tax law in this area.

Strengthening the estate tax

The estate tax was implemented 100 years ago, to impose a check on the growing intergenerational concentration of wealth and to generate much needed revenue. Loopholes in the estate tax enable the wealthy to dodge paying their fair share of taxes. While the nominal tax rate on estates is 40%, the effective tax rate is currently only about 17% for all estates that are taxed and under 19% for estates above $20 million.

Over its century-long existence, the estate tax has been significantly more robust, with higher rates and lower wealth exemptions, than the last two decades. The efficacy of the tax as a brake on concentrated wealth has been undermined, both by legislation and loopholes.

The estate and gift taxes have become riddled with loopholes that the wealthy exploit eroding the intended scope and revenue-raising potential of these progressive taxes. Instituting the rule to close one of these loopholes—valuation discounts—is an important step toward restoring the estate and gift taxes to their intended scopes.

Much misinformation has been spread about the estate tax, some of it in testimony earlier today:

  • Opponents claim it impacts low and middle income families. In fact, the federal estate tax is levied on an individual’s estate worth more than $5.45 million (or $10.9 million for a married couple’s estate). Estates worth less than those amounts pay nothing.
  • Opponents claim it hurts small businesses and breaks up family farms. In fact, only about 20 small business and small farm estates in the entire country owed any federal estate tax in 2013, according to the Tax Policy Center.
  • Opponents claim it disproportionately impacts racial minorities. It doesn’t. The estate tax is paid by just the wealthiest 0.2% of estates in the country, fewer than 2 out of 1,000 estates. That’s roughly 4,700 estates in any given year, according to the Joint Committee on Taxation.
  • Opponents allege it is a form of double taxation. In fact, the bulk of assets in the biggest estates that are subject to the estate tax are unrealized capital gains that have never been taxed. No one who relies on a paycheck to make a living is impacted by the estate tax.

The valuation discount rule seeks to close a loophole that the ultra-wealthy exploit to dodge paying their taxes. Other explanations you may have heard today are intended to obscure this very basic fact.

Why address valuation discounts?

The valuation discount loophole enables estate planners to place assets in specially created companies and other entities for the sole purpose of reducing the asset’s value for tax purposes. This technique can discount the value of assets by as much as 40%, artificially reducing the value of an estate below the taxable threshold.

Like many aspects of our tax code, the technical details are complicated but the concept is fairly simple. If I own an asset worth $100 million and I’m looking to dodge the estate tax using the valuation discount loophole that we are discussing today, here is how I’d do it.

I could create a limited partnership and place $100 million in assets in it. My wife and children also contribute assets. Because control of the partnership is disbursed among a group of people, our estate lawyers would argue the partnership interests would be harder to sell, and therefore each person’s individual share should be assessed at a lower value. After I’m gone and my estate is taxed, my partnership interest could be discounted up to 40% using the valuation discount loophole. So, a $100 million asset becomes a partnership interest worth $60 million. With an estate tax of 40%, that’s an estate tax break of up to $16 million.

For the ultra-wealthy households who take advantage of this loophole, there’s no problem here. But for the overwhelming majority of families, this loophole means less revenue for vital public programs they depend on. The estate tax is the only time that this wealth is going to be subject to tax since the heirs will receive all bequests tax-free.

What is the impact of this tax cut giveaway to the wealthy? Consider that closing this loophole could generate up to an estimated $18 billion over 10 years. In essence, by giving an $18 billion tax break to the wealthiest households in the country, we are collectively choosing not to address serious and significant social problems.

For example, for less than $15 billion we could help end family homelessness by helping 550,000 homeless families with children pay for housing over the next 10 years at a cost of $11 billion. In addition, we could also help a million young people get their first job through partnerships with businesses and communities ($3.5 billion).

It is unconscionable that tax loopholes exclusively benefiting the very rich should be allowed to continue. We’re hopeful that closing the valuation discount loophole is just the first of consistent efforts to preserve fairness and balance in the tax system, including by protecting the integrity of the estate and gift taxes.