Is the Estate Tax Fair?

People who are engaged in estate planning must be concerned about the looming specter of the estate tax. The current estate tax exclusion is $5 million and the rate of the tax is 35%. So if you have more than $5 million, the portion of your estate that exceeds $5 million will be whittled down by more than a third when it comes time to pass along your legacy to your loved ones. While this might not sound like a problem to the average person, when 2013 rolls around the rate of the estate tax is set to rise to 55% and the exclusion is going to be reduced to $1 million (unless there are changes to the laws between now and then).

A lot of people think that the estate tax is fundamentally unfair, and they have some pretty good talking points. Perhaps the most powerful one is the fact that the estate tax is an instance of double taxation. Let’s break this down to a very simple example to illustrate what is meant by this. Suppose you saved 20% of every paycheck that you earn from the time you start your first job all the way through to your retirement at age 66.

That money that you accumulated was drawn from the after-tax income that you earned. You paid income tax and payroll or self-employment tax on earnings before you receive your net pay. While you’re alive and that money is in the bank, the government has no cause to tax it. But the government considers your death a taxable event and taxes a second time the money that you did not spend during your lifetime — the estate tax is essentially a tax on savers.

Because of the perceived unfairness of the estate tax, many people would like to see it repealed.  A number of bills have been introduced in Congress this year to do just that, but given the federal deficit and concerns about reducing revenue, passing such a measure may be a difficult task.