Why is there an Estate Tax?

I can’t think of a better time to be taxed. It isn’t like I will notice.

The IRS mindset is if you start the day with a dollar, and end it with two dollars, they want to tax you on the “income”, so the estate tax fits with that. Is it right? We could argue that point forever. Fortunately the exclusions before the estate tax comes into play are so high most individuals never have to worry about it. and with a small amount of planning most people can avoid it.

There really isn’t much of one anymore. The first 5.34 million is exempt.

The first $5,340,000 is tax free. Also with a little planning the wealthy can have their accountants work out all kinds of tax loop holes, generation skipping trusts, and direct transfers. Don’t worry about it. Anyone who cares about this will be ok. They’ll manage.

“We have the choice of taxing a small percentage of the wealthiest who certainly can afford it, or we can cut social programs for those who need them,” said Abigail Disney, a philanthropist and filmmaker and heir to the Disney fortune.

Link

For every increase in Estate taxes there are a myriad of offsets some prefer to call loop holes. Estate taxes are a fluid, dynamic and slippery slope that if you indeed qualify to have an estate over the 5 million plus allowed amount you do need to seek the counsel of a qualified tax attorney. @Wealthadvisor may be in a better position to offer advice here.

@jaytkay Abigail was a silver spoon moron who obviously had no clue to what money meant to Walt nor how that money is wasted by the very Government she is championing

“What is the justification for taxing someone’s assets left upon their deaths?”

Simple. Because they can. And who brings them to task for their criminally insane overtaxing of us?

Remember, this is the capitalist system. It’s all about the Quan {See Jerry Maguire}!

Apparently the point of capitalism is winning. winning in capitalism requires that you end the game with all the money.
If you die with a large pile of do ray mi, the powers that be are going to take some of it. They’ve been doing it for thousands of years.,

And of course, as always, it is in the power of the masses of peoples (citizens) in the lower financial strata to end this nonsense, but they only occasionally do so.

“Were those assets not taxed while the person was alive?”

Sometimes, though not always. Unrealized capital gains (investment profits that exist on paper but have not yet been cashed in) can accumulate on things like stocks and properties. If one dies before realizing these gains, they can be passed on to one’s inheritors while also escaping all or most of the capital gains tax. This is a common argument in favor of the estate tax, though the loophole could conceivably be closed by other means.

People above said it already, estates don’t start getting taxed until over the $5million mark, so very few people even pay estate taxes. I’d much rather my estate get taxed then get taxed more while I am alive. The tax money has to come from somewhere. Pretty much every time money changes hand there is usually a tax. Spouses are exempt from the tax for the most part.

Also, people can give away money each year tax free. It might be $15k now (check me). Parents can give each child ~$30k ($15k each; again I would need to check the law for 2014) every year tax free and spend down their money.

2014; $14,000 per individual tax-free gift to as many people as you like, not just children, but the mailman or the local highway supervisor who repairs the potholes. IRS.gov

In the context of modern republicanism, and capitalism, it in theory prevents a propertied elite (an aristocracy) from emerging. Going back further, to feudalism, it was probably more regressive – an opportune time for a lord to make some cash in the process of assigning a lease to a new tenant, who happened to be the offspring of a deceased tenant.

Let’s remember the people with wealth over $5million don’t have all their money taken away, it is just a tax for the monies over $5million, so their heirs are getting a lot of money still.

@GloPro Are you still worried about the estate tax after what you have read here?

@gailcalled Good point about the money being given to anyone, I was thinking children because the OP mentioned heirs. Plus, anyone can be an heir, they just need to be named as such or be in line to receive the estate.

@JLeslie Am I the only multi-millionaire Jelly? just kidding
I’m not really worried, I’m just trying to learn more about them. I knew there was gifting, and what @SavoirFaire mentioned rang true with my thinking that my stocks aren’t worth shit until I sell them, so it makes sense that they would be taxed upon getting cashed in. If the family cashed them in…
I get conflicted in my thinking of what is fair and what isn’t when I see so much wasteful spending by the government. I get angry that they seem to always find ways to take what’s mine before they learn to manage what’s theirs (through taking from me… But I agree in necessary taxes within reason).

We should be clear here…

We have this: “A fleet of Lockheed Martin Corp. (LMT)’s F-35 fighters will cost $857 billion over 55 years to operate and support, 22 percent less than previously estimated, according to the head of the Pentagon office developing the plane.”… Does this bug you or are you all upset about food-stamps?

@GloPro I hate wasteful spending by the government also. What I hate even more is not paying for the spending and putting our country in jeopardy financially. All those votes to raise the debt limit. Waste of time, because we should not come to that in my mind.

If we are going to get political, I am under the impression the Republicans babble about estate tax the most, and most of the average Republicans think that their money will be taxed at their death. They don’t actually know the laws surrounding estate tax and the politicians love it. Many democrats don’t know the laws either, but the party isn’t harping on it as a manipulation. The average person will not be paying estate taxes.

Many Republicans hate the government to get any of their money (I realize you said you are ok with reasonable government spending) and then they are against gay marriage which would protect people who are together as a united couple from estate taxes. There is no way around that. Gay couples can write up directives so their partner can make decisions for them in the hospital when they cannot speak for themselves, but there is no way to write up a legal document to say their partner should not be taxed when they inherit the estate.

Also, regarding taxes most people think when they get into the next tax bracket (I’m talking about living people now) that their entire income is taxed at the higher amount. That’s false. It is only the amount in the next tax bracket.

I hear bunches of republicans saying they pay 50% of their income in taxes and it usually is not true mathematically. It usually hovers around 20% of actual gross income for the average person that you pay the IRS by April 15th and then there are other smaller taxes and state taxes if you live in a state that taxes, but rarely does it reach 50% for the average person. People never actually do the math. Even if they do their own taxes the average person uses the tables and never does the math to figure out what percent of their income they actually paid. I assume you recently did your taxes, do the math if you are curious and see if the number surprises you. You might not be surprised, but many people would be.

I’ve said it before and I’ll say it again, they should have accountants on these stupid news shows not politicians and various talking heads who really never talk about how taxes work and what the laws actually mean to the average person working every day.

Above the $5,340,000 (for 2014) tax free exemption, the tax rate is 40%. That means if some lucky recipient has a wealthy relative with an estate of $100M they can walk away with over $65M just for having the fastest sperm cell hit the egg – no work or skills required.
This explains the likes Paris Holtin (intentional misspelling).

In reality there are many ways to get around this. A classic trick is to give greatly appreciated stock to the heir. The stock basis then becomes the value at the date of death so nobody pays the capital gains tax. Neat .
For example, let’s say a stock lot was worth $1 million in 2004 and it is now worth $5M in 2014. If grandpa would sell it, he will have to pay tax on the $4M capital gain. But if it goes to his heir, the heir now gets to value it at $5M. Poof! 4M of capital gain gone! If it goes up to $6M he can sell it and only pay cap gains on $1M.
There are many other ways – See your tax professional: “Saul Goodman”

@LuckyGuy That doesn’t even count that when the wealthy die at an older age, let’s say after the age of 65 (not that 65 is old) they usually have been doing things for years before their death to give their children and relatives money to spend down their wealth. In essence the heirs get more than just the $5.34 million. Also, to add to your example, if the person’s estate is worth “only” $6million, the bulk of their estate is not taxed at all, and then a little bit is taxed at the 40%, so in the end there was barely a tax on the entire sum of money.

I wish I had to worry about taxation on my estate when I die or my parents. LOL. I’m not sure if the $5.34million threshold is permanent? It might expire and need another vote? Or, maybe it was that I read that some people want to bring it back down to around the one million dollar mark? Still not a problem for most of America.

@JLeslie I was just showing that as one small example of the mix of schemes used to avoid tax.
Complaining about the estate tax is a way for the wealthy to placate the unwashed masses and make them feel that justice will be done.
It works.

Don’t forget the 18 states and DC that impose a state estate tax. My mother died three years ago and was a MA. resident. It (and the MA. lawyers) certainly got their pound of flesh. Her lawyer is in Manhatten and insisted we consult with a MA. tax lawyer as well.

“Massachusetts taxable estates (gross estate minus allowable deductions) in excess of $1,000,000 are subject to the Massachusetts estate tax. The Massachusetts estate tax exemption is not indexed for inflation. For married couples that effectively combine their exemptions the aggregate exemption amount doubles to $2,000,000.

The Massachusetts estate tax is a graduated tax with rates ranging from .8% to 16%. ” Source

@LuckyGuy I know. I was just adding on to your statement.

@gailcalled Good point. I don’t know the current thresholds for any of the state estate taxes, they used to vary quite a bit from state to state. Most of the northeastern/New England states have some sort of state estate tax and a few other states scattered around.

The lawyers making their share is annoying to me.

Delaware, Connecticut, Illinois, Kansas, Maine, Maryland, Minnesota, New Jersey, New York, North Carolina, Ohio, Oklahoma, Oregon, Rhode Island, Tennessee, Vermont and Washington are the other states.

@gailcalled Some states have inheritance taxes. I’m not sure what the actual difference is between estate taxes and inheritence taxes. Are you including those? I think you are missing some states. I am pretty sure KY should be in there. They have either an estate tax or an inheritance tax.

Where not to die in 2014’

@JLeslie ; I did some of the research; your turn now.

@gailcalled The map on your link reflects KY having an inheritance tax. I found this which seems complete, but obviously the best way to check which states have what tax would be to consult the individual state websites.

I believe that the original reason for estate taxes was to try and discourage hereditary wealth (as in Great Britain’s history) by taxing those whose estates would create a non-egalitarian society.

That goal, which is certainly debatable, has of course been bastardized by political types on both sides. And social improvement aspect of estate taxes has been watered down by the various exceptions and loopholes now included.

The fundamental question, at least to me, is: if we believe in the principle of “no taxation without representation ” (the original Boston tea party slogan), then who is representing the dead guy who is paying estate taxes?

@elbanditoroso In a way the dead are still represented. There are laws to protect their estate. If they die without a will, the law tries to distribute the estate to what hopefully is fair among their descendants.

Estate tax has been around in one form or another as early as 700 BC. There was a 10% tax on the transfer of property in Egypt.

In the United States, the tradition of taxing assets at death began with the Stamp Act of 1797. The money was used to pay off the debt of the undeclared naval war with France in 1794. It was repealed in 1802. The estate tax was used on and off to finance wars over the next 100 years.

The estate tax as we know it was introduced with the Revenue Act of 1916 which also introduced the current income tax. This was all started under the Woodrow Wilson administration. In 1924 the gift tax was introduced. During the 1920’s through 1940’s the law was designed to redistribute wealth. It was designed to prevent wealth becoming increasingly concentrated in the hands of the wealthy few.

Slowly the estate tax is being eliminated. Currently the first $5,340,000 for a single person or $10,680,000 for a married couple is exempt from federal estate tax. This is up from the $1,000,000 just 14 years ago.

While it had been mentioned that there are loopholes that can be used to reduce the estate tax further, they are really are not loopholes, but laws that allow money to be placed in irrevocable trusts to avoid estate tax. What needs to be pointed out that once the money is placed in trust, the corpus is no longer available to the individual. If it become available, it goes back into the estate. Thus, income from trusts are generated each year, subject to income tax, while the principal remains in the trust.

@johnpowell Well, even if we don’t all agree on what constitutes wasteful spending, I don’t believe any of us deny it exists. There are so many cracks our tax dollars fall into that no one can even explain… It’s so frustrating.
@Wealthadvisor Thank you for a thorough answer. It’s interesting that estate tax originally funded war. Also, when you say $10.68 million per couple, do they have to die at the same time? And what budget does the estate tax currently fund? Is it still war, or is it allocated more loosely?

The way it currently works is there is currently an unlimited marital deduction between husband and wife. So if the husband died as was worth $50,000,000, he can pass the entire $50 million to his wife estate tax free. The tax is incurred when the wife dies, (the second death.) If the husband did not uses any of his exclusion, $5,340,000, (this can be reduced by annual gifts over $14,000 to avoid paying gift tax.) You can either pay the tax or use some of your lifetime exclusion.

The wife would then have the husbands $5,340,000 exclusion available to add to her $5,340,000 for a total of $10,680,000. This would then mean $39,320,000 ($50,000,000 – $10,680,000 = $39,320,000) would be subject to estate tax. That amount would be taxed at a rate of 40%.

The estate tax today is still an attempt to redistribute wealth. The money now goes into the general fund.

Not all tax is to redistribute wealth. The wealthy get tax breaks that other people cannot utilize. Maybe taxing their estate helps to balance that out. I understand that part of the reason originally for estate tax was so the rich did not get much much richer simply by the inherent advantage generational wealth. Not to mention in America it sort of was against what we fundamentally stood for regarding individual merit and a desire to leave the system or royalty and aristocracy.

Not all tax is to redistribute wealth is correct. But if you look up the definition of estate tax, you will find its main purpose was for the redistribution of wealth. Income tax does not fit into that category.

“they are really are not loopholes, but laws that allow money to be placed in irrevocable trusts to avoid estate tax”

For the purposes of taxation, a loophole is a law or gap in a law that allows someone to avoid taxation. So what you’ve said here is, “they’re not loopholes, they’re just [insert definition of a loophole].” I don’t mean to nitpick your answer, which I agree is both thorough and informative. It’s just that loopholes are loopholes, whether created purposefully or not.

No, they are not loopholes. They are in the tax code as part of the law. It allows people to do estate planning. A loophole is usually a part of the law that was overlooked when crafting the wording that allows people to take advantage of the mistake or error until it is closed.

Irrevocable trusts have been around for years as part of the estate tax law. It says you may protect money from estate tax if you are willing to give up ownership, (the trust owns the money,) and control, the trustee manages the money.

Loopholes and law are not the same thing.

To be more clear, a loophole is an ambiguity in the law. Trusts are in the law and are not an ambiguity.

Just another reason for Uncle Same to put their hand in your pocket. Dead or Alive.

@Wealthadvisor I disagree. A loophole can be an ambiguity, but it could also be a gap (purposeful or accidental) that allows people to break the spirit of the law without breaking the letter of the law. This is part of the standard definition (where a loophole is either an ambiguity or an inadequacy), but also fits with ordinary usage (which treats it as perfectly appropriate to talk about building loopholes into a law).

@SavoirFaire There is nothing ambiguous about loopholes. All loopholes are as intentional as the taxes that they circumvent. These loopholes are reach-arounds for the wealthier benefactors so that in reality the taxes are more palatable for all parties involved. Today’s article on the taxes that Obama and Biden each paid for income in 2013 is highly illustrative of this loophole dynamic. Both earned well over $400,000 dollars yet only paid effective tax rates in or around 20%. Most liberal hand waving I hear as of late wants the high income earners like them to pay higher tax rates yet the #1 and #2 leaders of our country are paying a tax rate less than the average middle class wage earner all because of the legal tax loopholes that exist and they exist as a big secret that only the wealthy and their accountants are aware of. People only hear about stick to the rich while in reality the rich including high profile Democratic leaders are sticking to the low and middle income electorate.

I am in that awful (or lucky, depends on your perspective) spot where I don’t make enough to take advantage of a bunch of loopholes but am paying the full 30% in taxes this year. That’s what I get for not financing my home.

@Cruiser I have no idea why you are addressing your post to me. It was @Wealthadvisor who was arguing that a loophole is an ambiguity in the law. Furthermore, we were talking about the definition, whereas you seem to have just been looking for an excuse to go on a political rant.

@Cruiser may have a point, @SavoirFaire. Afterall, we know that people in Congress don’t typically read what they vote for (and couldn’t possibly!). Someone probably does stick them in deliberately, and they’re overlooked until they become law. At least I wouldn’t be surprised if that happens a lot.

But, @Cruiser: so what about Obama and Biden’s tax rate? You can disagree with the tax rate all you want. You still have a legal right to pay the rate you’re entitled to pay legally given your own mix of credits and deductions. Ayn Rand collected social security, afterall. She may have been a truculent sociopath, but I don’t think that makes her hypocritical.

@bolwerk But that in no way contradicts what I said. In fact, it fits right into what my point was all along. Loopholes can be ambiguities, but they can also be deliberate. I can’t figure out why people are having such a hard time distinguishing my position from @Wealthadvisor‘s position.

@SavoirFaire: I didn’t say it contradicted your point, or anyone’s point. I addressed your last comment to @Cruiser – mere unintentional ambiguity might be more rare than we would suppose.

Which, again, would be better directed at @Wealthadvisor given that he’s the only one who has said loopholes are always about unintentional ambiguity. But whatever.

@Judi Are you sure financing your home would have helped? I don’t know the price of your home, but when I did the math on my house it didn’t help. Paying the interest on the loan was more expensive than what I would have saved in my tax return. Plus, you have to get over the threshold to itemize on your taxes for it to do you any good anyway. I think it is around $10k in interest income and the other stuff you can lump in like property taxes? Maybe if you pay high property taxes and high state tax that adds up for you and it does make sense. One trick to get a deduction is to pay two years of property taxes in one. Usually property taxes can be paid October-March more or less, so you can pick what year you pay. In TN I could pay in Jan, and the. For the next year pay by Dec, and use the deduction, and then the next year I didn’t pay any property tax in that calendar year so not deduction, but it didn’t matter since I would not meet the threshold anyway.

In FL we get a discount if we pay property taxes early, so that changes the math.

@SavoirFaire my comment was directly at this statement of yours…. “A loophole can be an ambiguity” Again IMO a loophole is anything but ambiguous. The only thing I would disagree with wealthadviser is that IMO loopholes are intentional bargaining chips perhaps meant to look ambiguous but are intentionally left to allow for the bi-partisan “give and take” that goes on in writing these tax laws. If you give me this tax increase I will let you have this loophole. Taking advantage of these loopholes is often very thin ice to tread on and you better have the stomach to take some of them in the event you get audited.

@bolwerk My only grudge is that Obama and Biden are the defacto parade marshals for the liberals who want to drain the 5%‘rs of all of their wealth and they did a better job at dodging the tax man than I did. Maybe I just need a new accountant.

@Cruiser But you failed to understand that comment in context. I allowed that there might be some cases where a loophole was an ambiguity, but was arguing that they are often intentional. It was @Wealthadvisor who was arguing that they are always ambiguities. Now, it’s clear that you don’t agree with the claim that they are always ambiguities. But unless you are prepared to argue that there has never been a case in all of history where someone exploited an ambiguity in the law in order to receive a tax advantage, the only position left is mine. This is incredibly simple, and I’m not sure why you’re having so much trouble with it.

@Cruiser: even if that were true (it’s not), they still have a right to pay according to the code that exists.

You are trying to fit a square peg into a round hole.

“But unless you are prepared to argue that there has never been a case in all of history where someone exploited an ambiguity in the law in order to receive a tax advantage, the only position left is mine. This is incredibly simple, and I’m not sure why you’re having so much trouble with it.”

You are making my point. Ambiguity’s have been used to take advantage of a tax law. That is correct. But, an irrevocable trust, marital by pass trust, credit shelter trust, qualified personal residence trust, grantor retained annuity trust, dynasty trust, charitable lead trust, etc., are all part of the estate tax code and are not ambiguities. They are part of the law. Congress made those tools available to those who wish to use them. You do not have to use any of them.

Here is an example of a loophole in the tax law:

One of the earliest tax loophole situations involved the so-called “marriage penalty.” When it came to assets and income accumulated throughout a fiscal year, couples who claimed married status sometimes found themselves paying more taxes than an unmarried couple claiming the same income. Since the definition of marital status would only apply to the last day of the filing year, however, if the couple could obtain a quick legal divorce in a foreign country by December 31st, they would be considered single and avoid paying additional taxes. The couple could then remarry legally in the United States during the following year and repeat the process.

A tax loophole is usually considered a murky legal maneuver. Many legitimate business and personal deductions are already well-defined in the existing tax codes, but some individuals and corporations may feel comfortable claiming even more deductions based on the ambiguity of the language. If the filer’s tax records are selected for an audit, all of these deductions can be called into question. Because of this yearly auditing process, most loopholes rarely survive more than a few years before some corrective legislative action is taken.

http://www.wisegeek.org/what-is-a-tax-loophole.htm

Some of the above mentioned trusts have been around for more than 75 years. If they were loopholes, they would have been closed. They were not, and thus are not tax loopholes.

@Wealthadvisor You seem to have caught the context disorder that is spreading on this thread. My view is not and has never been that loopholes are never ambiguities. So we agree—and have agreed all along—that at least some loopholes are ambiguities. The point of disagreement is whether or not all of them are. So when you say that passage is making your point, you are failing to recognize what is in dispute.

You have yet to offer, however, any counterargument whatsoever to my claim that there can be loopholes that do not arise from ambiguities. The definition of a loophole is an ambiguity or inadequacy in the law. Your own link confirms this by defining a loophole as an exploitation of tax law to reduce or eliminate one’s liability (and using qualifying terms like “usually” when talking about ambiguities). One can exploit without taking advantage of ambiguities. Note that this is not to claim that all methods of avoiding taxes are loopholes. It is only to claim that there may be loopholes that do not arise from ambiguities. One clear way of doing so is to take advantage of the way laws interact. There could be no ambiguities in either law while still resulting in the ability to use one to dodge the other.

Finally, your claim that loopholes are always closed is a non sequitur. And indeed, this is the point on which I agree with @Cruiser. Insofar as some loopholes are created intentionally—whether through ambiguities or not—there is no reason to expect them to be closed. So while you seem to be hung up on a particular sort of trust, you are failing to note that the point at issue is not over any particular way of dodging a tax (and certainly not the estate tax, since the conversation has been about not how to avoid it but about what sorts of loopholes it might close).

@SavoirFaire I appreciate you taking the time to clarify the ambiguous nature of employing the words “always” and “some” when trying to make a point. Those words are often unintentional in making ones point that then can be returned as an absolute by another’s own interpretation.

IMO loopholes are deemed ambiguous by those that are least familiar with them. When they are then captured as a tax deduction, they are anything but ambiguous.

I agree with you about loopholes. But Estate Planning and all the tools used to accomplish that planning are written into the estate tax law. They are not loopholes.

Here are some tax saving items written into the tax law.

1. Mortgage interest deduction.
2. Medical deductions
2. Property tax deduction
4. Investment losses
5. Charitable deductions.
6. Personal exemptions

These are part of the tax code that allows the taxpayer to deduct those items to save on taxes. They are written into the law. They are not loopholes. The same can be said for Estate Planning rules.

Loopholes are not usually created intentionally. They are usually created by some attorney who thinks they can apply a certain tax definition to the law to get around paying taxes. They are trying to create a loophole in the law.

@Wealthadvisor you and I see these tools as legal tax saving vehicles and liberals who resent the wealthy see them as loopholes. I agree that interpretation is a large part of one taking advantage of ones interpretation of the tax laws…and saying that, I change my answer that those most familiar with the tax laws are the ones who make them just that more ambiguous by their own interpretations and liberties they take with the write offs they take. It is a gamble millions take on their income tax returns

So everyone has come to agree with @SavoirFaire, but it’s @Wealthadvisor who gets the GA’s. Typical Fluther…

@Cruiser I’m not sure you’re using “ambiguous” right. @SavoirFaire and @Wealthadvisor were talking about ambiguities in the law, which are things that could be interpreted in different ways or aren’t clear enough to rule out a particular action. Something can be ambiguous even if the tax savings someone gets out of them are very clear. In fact, I don’t even get what it means to say that when loopholes are captured as a tax deduction, they are anything but ambiguous. That doesn’t tell us that the deduction wasn’t achieved through an ambiguity in the law.

@Cruiser I’m not a liberal, but I can still recognize certain things as loopholes.

@Patton The points are meaningless. Don’t trouble yourself about them.

@patton IMO they are one in the same. Tax attorney’s and accountants make a terrific living exploiting the gray areas of the tax laws. Even my own accountant is very good at winking and nodding. Plus you may have missed my last answer….” I change my answer that those most familiar with the tax laws are the ones who make them just that more ambiguous by their own interpretations and liberties they take with the write offs they take.”

@Patton: maybe some of the confusion here is @SavoirFaire‘s comment here casts a somewhat broader net than the one here. I think what @Wealthadvisor is saying is it doesn’t fit either of the two criteria in the second comment: there is no ambiguity about the purpose of the deductions or irrevocable trusts, and there is no reason to think these tools he mentions are undermining the purpose of tax law because they are part of the purpose of tax law.

An irrevocable trust (or any trust, really) does come with tradeoffs and advantages for the public and tax authorities. The assets stay in the economy as investment capital and (hopefully) generate taxable revenue. The trustees lose their rights to the principal. I wouldn’t call it a loophole myself.

@Cruiser Okay, your last answer makes it clear.

@bolwerk I don’t think the two comments cast different nets at all. But it doesn’t matter. @SavoirFaire never said that irrevocable trusts and the like are loopholes. He just said that not all loopholes come from ambiguity. Some come from gaps in the law, like the one that would exist for capital gains if the estate tax was abolished.

@Patton: he appeared to say exactly that about irrevocable trusts here (it is in response to a comment by @Wealthadvisor here, if you want the original context). I don’t disagree with his definition in the second answer (here), but it does go from defining a loophole rather over-broadly in the first quip to rather more narrowly and explicitly in the second.

I also don’t see a good case that an irrevocable trust meets even that narrower definition to be called a loophole. Very deliberately, the government is offering an alternative to the estate tax that may be in the interest of the very wealthy under some circumstances, but also offers long-term advantages for capital markets (and therefore the government’s means to collect future taxes). Certainly I can’t see how something as explicit as irrevocable trusts can be said to be an “ambiguity,” however maybe they undermine the spirit of the law in some way I hadn’t considered.

@bolwerk You linked to the same comment twice, so I’m not positive I know what my “two definitions” are supposed to be. To my mind, I have been operating on only one definition of a loophole: an ambiguity or inadequacy (aka “gap”) in the law—whether purposeful or accidental—that allows one to break the spirit of the law without breaking the letter of the law. Over the course of this thread, I have referenced parts of that definition in order to dispute various claims.

Furthermore, I have stated that trusts are not loopholes per se. Instead, they may act as loopholes in certain cases (e.g., when one avoids the capital gains tax in the absence of an estate tax). I take it from @Patton‘s ability to understand my point that this argument is not hidden within my posts in some inscrutable way.

Finally, note that I have never said that irrevocable trusts are an ambiguity. In fact, quite the opposite. It was only @Wealthadvisor who ever claimed that all loopholes are ambiguities, though he seems to have now abandoned that claim. (Perhaps your whisper text was not aimed at anything I said, but I thought it worth addressing in any case.)

I have not abandoned the claim that a tax loophole is an ambiguity. Perhaps an inadequacy in the law would describe it better.

http://en.wikipedia.org/wiki/Loophole

@SavoirFaire: I know, but apparently @Patton missed it the first time. It may not have been what you intended to convey, but going from “a loophole is a law or gap in a law that allows someone to avoid taxation” to the more exclusive “purposeful or accidental” you mentioned in the second link does narrow the scope. I don’t think there was anything inscrutable about what you said, but you were the one who complained about people not understanding you.

I’m less clear about the nature of the specific loophole you mention. As I understand tax law, in that specific case the security would pass from a person to a trust and avoid capital gains taxes to that point. The security would continue to generate dividends or coupons or whatever for the trust until expiration or disposal. At that point, applicable capital gains taxes would be levied. While the trust owns the security, the trustees don’t actually get their hands on its principal. That doesn’t seem wildly out of step with the purpose of estate trusts to me, so I’m a bit hesitant to call it a loophole.

There seems to be some misunderstanding on how a trust works.

First the trust is a legal arrangement that provides for the ownership, management, and distribution of property. It allows the minimizing of estate tax, protecting assets from creditors, and providing for family members who are minors, or who have special needs.

If you transfer more than $5,340,000, you have to fill out a gift tax form and pay gift tax on the amount over the $5,340,000.

The trust must file an income tax return each year. If the income is not distributed to the beneficiaries, the trust reports the interest income and capital gains and pays the income tax at the trust’s tax bracket. If the money is distributed to a beneficiary, then that person reports it and pays the tax. Just because money is in a trust does not exclude it from paying taxes on the gain. If it is a grantor trust, then the grantor reports all income earned by the trust on his individual tax return. This is an advantage to the grantor because the trust tax bracket is higher than the individual tax bracket.

Most of the time, money is not put in trust. It is usually life insurance. The trust is then called an ILIT, (irrevocable life insurance trust.) In this case, there is no money in the trust until the insured dies. Since the insurance is in trust, the proceeds are not in the estate for estate tax purposes. The insurance proceeds are used to pay the estate tax and then provide for the care of surviving spouse and beneficiaries. Since the insurance pays the estate tax, there is no reduction in estate value. The insurance pays the tax.

In summary, there is no avoidance of paying income tax or capital gain tax over the life of the trust. And there is no avoidance of paying estate tax. There is just a better way to pay the estate tax then to use estate dollars. Insurance dollars are less expensive than estate dollars.