Inheriting a mess

In recent years, the battle over the death tax has steadily increased in urgency. By the end of 2010, the year the death tax will temporarily be repealed, Congress must decide whether to permanently repeal it or to allow it to come back at its full rate of 55 percent in 2011.  

Nevada's senators continue to play an important role in this battle. Republican John Ensign has fought hard for repealing the tax, while Democratic Senate Majority Leader Harry Reid has been the most powerful opponent of repeal.

The Senate's most recent action on the death tax took place in the Finance Committee earlier this month, in a hearing to consider "Alternatives to the Current Federal Estate Tax System." The hearing may as well have been titled "Redistribution by Another Name."

The three witnesses giving testimony quickly made clear their support for maintaining, if not increasing, the "system of wealth transfer taxation" in order to reduce the "inequity of unearned wealth." According to witness Lily Batchelder, an Associate Professor of Law & Public Policy at the New York University School of Law, "unearned wealth" includes any inheritance.

This might be the view of left-of-center academics like Batchelder, but it is hardly the view of most Americans.

The "inheritance tax" proposed by the witnesses would theoretically place the tax burden on the heir rather than on the donor. The reality, however, is that an inheritance tax would operate largely the same as the existing death tax, but the burden on those affected – particularly family business owners and farmers – could be much worse.

Most striking is the proposed rate of taxation. The witnesses proposed that the inheritance tax start at the rate of the highest income tax bracket (currently 35 percent, but slated to increase to 39.5 percent in 2011), plus a 15 percent "surtax," for an initial sum of 50 percent immediately and 54.5 percent in 2011.

That’s not all. Batchelder wants to eliminate “stepped-up basis” for capital gains, which would effectively add another 15 percent to the tax rate. What she is essentially proposing is to do away with a capital gains exemption, and require heirs to pay full capital gains taxes on top of the death tax burden. Overall, the inheritance tax could approach 70 percent.

If the higher rate isn't bad enough, consider this: The inheritance tax gives tax preference to donors who break up their family property by bequeathing it to as many heirs as possible. For family business owners and farmers, this can mean leaving a share of the enterprise to heirs with little interest in its success, thereby dispersing needed capital.

Aware of the contention that this tax would fall even more harshly on family enterprises, the inheritance tax proponents crafted a "deferred" payment plan, whereby family business owners and farmers lacking cash could defer payment of the tax indefinitely until they sell the enterprise. During this time, however, annual interest would accrue on the amount of the 70 percent tax. This means that eventually, a family could theoretically owe 100 percent of its company's value to the government in taxes.

Moreover, until the tax is paid, the business would become a "borrower" of the federal government, making the IRS a silent partner in the business' operations, secured by an IRS lien. As any executive knows, the complications of nonproductive loans can wreak havoc on a business' ability to borrow money for growth. This "deferment" plan doesn't work on paper and would ruin family businesses in reality.

The good news is this plan is unlikely to go anywhere – at least in this Congress.

The bad news is a few influential members are trying to pass the buck rather than deal directly with the issue now. As majority leader (and previously as minority leader), Reid has done more than anyone to prevent repeal. In fact, last year Reid stopped a death tax repeal amendment from even coming to a vote.

While the Senate continues to consider an unrealistic "inheritance tax" proposal, family business owners and farmers across America face the looming harsh reality of a 55 percent tax on their life earnings in 2011. Sen. Blanche Lincoln (D-AR) understood the hearing's disconnect from reality, stating: "My family-owned businesses [in Arkansas] could care less what [the form of wealth taxation is called] … it has the same effect. Changing the method of taxation will not make this reality go away."

Nevada was built by hard-scrabble ranchers and visionary entrepreneurs. Today, the children of those pioneers remain the underpinning of Nevada's economic success. It's time for the Senate, under Reid's direction, to stop the strangulation of Nevada's family businesses and ranches – and to strangle the death tax instead.

Dick Patten is president of the American Family Business Institute and a policy fellow of the Nevada Policy Research Institute.