Reforming Estate Tax Would Pave Way for Equitable Tax Landscape

A win by Charles and Kathleen Moore in their fight against the US government on income realization would call into question numerous elements of the tax code and likely would bar any future wealth tax.

But while the outcome of Moore v. United States may have significant implications for the federal tax code, pursuit of a wealth tax in this legal and political landscape is fraught with challenges. In contrast, reforming the estate tax offers a more feasible approach to tackling wealth inequality—albeit a much less headline-grabbing one—and isn’t threatened by Moore.

The estate tax should be leveraged to achieve the wealth inequality goals previously pinned to a politically and functionally impossible wealth tax. Reform, rather than revolution, may be the only path remaining before us in the fight against wealth inequality—but it’s practical and administratively feasible.

Realizing the Problem

The Moore case hinges on whether income or gains need to be “realized” to be taxed—that is, functionally or actually received.

The concept is best defined in the opposite: If you were to purchase a stock for $10 per share, and it was to appreciate to $15 per share, you would have $5 of unrealized gains per share. Only when one sells such stock would the gain be realized and become income subject to taxation.

In the most abstract terms, the Moores are arguing that a tax on the $5 of unrealized gains, prior to sale of the stock, would be unconstitutional.

All current proposals for a wealth tax rest on the constitutionality of taxes that attach to unrealized gains. As such, a win for the Moores would eliminate that possibility for the foreseeable future.

That said, even if the realization requirement escapes the Moore court and lives to see another day, rolling the dice on a wealth tax before the same court would risk invalidating large swaths of the tax code. That risk shouldn’t be taken.

US bills

Photographer: Paul Yeung/Bloomberg via Getty Images

Estate Tax+

The Tax Cuts and Jobs Act of 2017 gutted an already anemic estate tax system. In 2020, only about 1,900 estates were of sufficient size to be taxable at the federal level—in 2001, that number was 50,500.

The cause of this drop was the raising of the estate tax exemption from $675,000 in 2001 to $5.12 million in 2012 and, finally under the TCJA, to $11.18 million.With a bit of forethought and planning, still larger estates can escape untaxed.

Dramatically reducing the estate tax exemption is the simplest way to carve the path to a more equitable tax system. Adjusted for inflation, the 2001 exemption would be equivalent to about $1.2 million today.

Expanding the tax base by reducing the bottom rate and raising the top rate, currently capped at 40%, to the 2001 top rate of 55% would help make the system more progressive. Also, introducing a minimum tax rate for high-value estates is a quick fix for the myriad deductions and exemptions that otherwise would whittle down an estate’s effective tax rate.

An elimination of the step-up basis would nearly replicate the concept of a wealth tax in the estate tax system. For example, if an investor purchases investments for $10 per share in year 0 and sees them appreciate to $100 per share in year 10, they can either sell the shares and pay a tax on their gains of $90 per share, or die and let their heirs take the shares with a basis of $100. Any theoretical tax owed on the $90 gains vanishes like tears in rain.

A wealth tax would function by creating deemed realization events—essentially taxing wealth as though some transaction had been made—at intervening years between 0 and 10 to tax the investor on their unrealized gains at those points. An estate tax system that doesn’t provide a stepped-up basis to inheritors would do the same thing but would collapse the events to just one—at death.

The inheritors wouldn’t owe capital gains taxes on their inheritance immediately, but would take the inherited property with the carryover basis, and the bill would come due at the time of a future sale. This means family homes and farms needn’t be sold immediately upon the death of the previous generation, and taxpayers wouldn’t be incentivized to hold on to their appreciated property merely to pass on basis advantages to their heirs.

A novel proposal came a decade and a half ago from Lily Batchelder, professor and Treasury Assistant Secretary for Tax Policy, who argued for a true inheritance tax—a tax on inherited wealth at the heir’s current income tax rate plus 15%.

Such a system would provide an incentive for the wealthy to consider leaving beneficiaries a portion of their estate that wouldn’t otherwise put them in the highest tax bracket. This system would give individuals who fall in lower tax brackets lower tax obligations on their inherited wealth.

Beyond Moore

As the Supreme Court deliberates over Moore, the future of a wealth tax hangs in the balance, but provides an opportunity to reassess what can be done to combat wealth inequality with existing legislative and regulatory tools.

The allure of a wealth tax is compelling. But the TCJA’s one-time mandatory repatriation tax’s contentious appearance before the Supreme Court should indicate a wealth tax likely wouldn’t survive the court’s scrutiny.

Considering these challenges, the estate tax stands as a much more pragmatic tool on firmer legal ground. By lowering the exemption threshold and rates to comparable levels to 2001, adjusting rates progressively, and eliminating the stepped-up basis, the estate tax can be reconfigured to target wealth accumulations—albeit over a longer timeline than a wealth tax.

Andrew Leahey is a tax and technology attorney, principal at Hunter Creek Consulting, and adjunct professor at Drexel Kline School of Law. Follow him on Mastodon at @andrew@esq.social

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