In 2001, Congress passed, and the President signed, a strange law regarding the federal estate tax. The plan was to gradually reduce the tax rate and gradually increase the exemption from tax. In 2010, the tax was to disappear entirely, but only for people who died in that year. You can imagine the planning that was contemplated. In the following year, 2011, the tax was to be restored to where it was before the change in the law, a much higher rate and a much lower exemption. This couldn’t be right. Everyone who thought about this situation thought that Congress would have to make some change in this scheme of taxation. But, surprisingly, the two political parties couldn’t agree on what the change should be. One party thought the tax should be abolished entirely, because, after all, it was mostly a tax on rich people. The other party thought it should stay as it was, because, after all, it was mostly a tax on rich people.

Now, we’re actually getting close to 2010, and some leaders in both parties have begun talking about a change to make sense of this law. The federal estate tax next year will be at a rate of 45% and the exemption from tax will be $3,500,000 ($7,000,000 for married couples). The proposal is to extend these numbers into the indefinite future. That’s probably not the end of the discussion of the federal estate tax, but it sounds like a sensible place for the tax to be for a while.

The federal estate tax is not, as it has been called, a death tax, nor is it a tax on death. It’s a tax on the accumulation of wealth, as compared with a tax on income, and it’s imposed when a person has died. No tax is imposed on amounts passing to a surviving spouse, nor on amounts given to charity. There are plenty of opportunities to transfer wealth during life at little or no tax cost. In a sense, it’s a tax imposed on those who try to hold on to their wealth, and the control it brings, until death. It shouldn’t be imposed on wealth that people might need to live on in later years, and that’s the point of the exemption from estate tax. It shouldn’t be the cause of destroying family businesses and farms, and there seems to be no evidence that the tax does so. To ensure that neither of those problems arise, the exemption might be a little larger, such as $5,000,000, and it probably should be indexed to inflation.

There is an excellent short book on the subject of the federal estate tax, called “Wealth and Our Commonwealth: Why America Should Tax Accumulated Fortunes” by William H. Gates and Chuck Collins. Mr. Gates’ son knows something about accumulating wealth. The book makes this point, which is worth considering: if people who have accumulated wealth under this country’s favorable economic system had been born elsewhere, they probably would not have acquired that wealth, or at least not as much. So, say the authors, perhaps something is owed to the country for the ability to accumulate and enjoy wealth.

The question of whether we should have a federal estate tax and at what level it should be imposed will remain unsettled for some time, but it’s helpful to see members of Congress talking about a reasonable compromise to avoid the absurd result that would occur under current law.

Republished with permission of The Legal Intelligencer.