Is a Wealth Tax Wise and Practical?

I’ve been following with great interest Democrat Senator and presidential candidate Elizabeth Warren’s proposal for a wealth tax. In a March 15, 2019 opinion entitled “Elizabeth Warren Actually Wants to Fix Capitalism,” New York Times columnist David Leonhardt writes that Senator Warren believes an annual wealth tax on net worth exceeding $50 million would generate more than $250 billion annually, paying for social programs she believes are vital to our continued prosperity.

Warren and some economists point out that our present system taxes our income but not our balance sheet, which would be more progressive. Many working-class Americans are taxed on all earned income, while wealthy individuals pay lower capital gains tax rates, avoid income taxation altogether on certain investments (such as state and municipal bonds), and largely avoid, or at least minimize, the federal estate tax, especially with the current exemption levels exceeding $11 million.

When wealthy individuals make large lifetime gifts or bequests at death, the gift, estate and generation skipping transfer taxes (otherwise known as “transfer taxes”) are imposed. This is a balance sheet determination of the fair market value of amounts transferred to a loved one.

Western governments imposed and collected transfer taxes as early as the 17th century, usually to pay for wartime expenditures.  They became a staple of the American tax system under Presidents Theodore Roosevelt and Woodrow Wilson in the early 20th century as a revenue enhancement as well as a means to address social inequality, and not allow for great concentrations of wealth to be held in the hands of a “ruling class”.

In England, Winston Churchill argued that estate taxes are “a certain corrective against the development of a race of idle rich”. This issue has been referred to as the “Carnegie effect,” for Andrew Carnegie. Carnegie once commented, “The parent who leaves his son enormous wealth generally deadens the talents and energies of the son, and tempts him to lead a less useful and less worthy life than he otherwise would”.

Warren extends this philosophy to an annual balance sheet tax. Most of us pay, directly or indirectly, property taxes, which are also a balance sheet tax based on the value of one line-item, real estate. So working class families pay an income tax and a partial balance sheet tax. Essentially income and the major asset that many working class families own is taxed. Warren wants to broaden the balance sheet tax for wealthy individuals to encompass their entire net worth.

As Senator Warren proposes, an annual wealth tax would break up concentrations of individual wealth while providing a means to correct “economic fairness,” which itself is a nebulous phrase.

As anyone who has ever filed a Federal Gift Tax Return Form 709 or a Federal Estate Tax Return Form 706 knows, determining a date certain, fair market value of one’s balance sheet is a largely subjective exercise, especially when one owns commercial and rental real estate and/or closely held business interests.

As opposed to publicly traded stocks, whose value is easily determined at any given moment, determining the “fair market value” for difficult-to-value assets can take many months and cost many thousands of dollars. First, the taxpayer hires an appraiser to determine the value of land, building and other hard assets. Next, a business valuation specialist must then address the value of the shares, partnership or membership interests of the company or partnership that owns the hard assets.

The share/partnership interests are usually discounted because closely held business interests can’t be easily liquidated (as opposed to shares of publicly traded shares of stock), transfers are restricted by agreement among the shareholders and partners, and other factors, such as minority interests that can’t control the direction of the company or partnership.

What about foreign assets owned by a wealthy person? Presumably those would be included in the computation, otherwise the wealth tax could be easily avoided by establishing foreign entities to own domestic stocks, bonds and real estate.

Intellectual property also poses difficult valuation obstacles. How long can one expect the income stream to last? What will future sales look like? Will the underlying service or product be usurped by new and better products, services or technologies?  This not to mention how complicated irrevocable trusts and other ownership devices play into whether an asset is even part of the balance sheet of any particular taxpayer.

Determining these values for a one-time gift or as a date of death value is difficult enough. I can’t imagine the regulatory, compliance and enforcement costs associated with an ongoing, annual wealth tax.

The debate is just now starting and will presumably last through the 2020 presidential election. I wonder whether this wealth tax that many candidates are sure to endorse is intended merely as a campaign pledge to gain votes or are truly something intended for a legislative agenda. One selling point is obvious. “There aren’t many individuals that will be subject to the tax because the floor is so high.” That was the original, persuasive argument for the imposition of an estate tax. You may recall that in the early 1970s the federal estate tax exemptions fell to the point where many regular working-class individuals were affected, as those whose estates above $250,000 became subjected to the tax.

I suggest that any wealth tax act should be labeled “The Trust Attorney’s Full Employment Act”. It certainly will be interesting to follow.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Academic Pressures

Most of us are familiar with the college admissions scandal in which wealthy and accomplished parents allegedly lied, cheated and bribed to get their children admitted to elite universities. Wall Street Journal columnist Peggy Noonan wrote an excellent essay on the topic in the March 14th edition. In it she offered her explanation that these parents view their children as narcissistic extensions of themselves, and consequently used whatever means necessary to gain advantage.

Noonan added that her experience teaching Ivy league students was less than ideal. She didn’t like their attitudes toward other classmates and considered themselves superior simply because they were admitted to a prestigious university. She contrasted her experience with how polite, sincere and genuine students acted at a second-tier school in Tennessee.

Regular readers of this column know that I have three daughters, one of whom graduated with bachelor’s and master’s degrees from Brandeis University, which is often viewed as an elite university. It certainly was expensive enough! My middle daughter is graduating from the University of Florida this May and will continue for her doctorate in physical therapy while my youngest earned an honors fellowship at Elon University in North Carolina.

While I can assure you that I didn’t bribe any coach or admissions officer, today’s application process is emotionally grueling both for student and parent. The process seems arbitrary and often makes no sense which kids are admitted, and which aren’t into a given institution.

Criminality aside, the competition to gain admittance to even popular state schools like the University of Florida is fierce. I’m a three-time UF grad but I’m not certain that my high school grade point average and SAT scores would gain me admission today.

The high school and college experience of today, I’m afraid, is exponentially more difficult and stressful than what my generation experienced. All three of my daughters graduated summa cum laude from Fort Myers High School’s International Baccalaureate (IB) program. The studies were rigorous. Over my daughters’ high school years, my wife and I had to calm down several anxious crying spells leading up to exams as our daughters were overwhelmed with projects and homework.

Gaining admission into even the best state schools requires building not only an academic resume but one that highlights athletic, civic and community involvement. It seems that our modern pressures have stolen at least some of the innocence and the care-free nature of youth. And even with all that, the high school counselors will tell their students that certain schools will be a “reach.” Students are encouraged to apply to one or two “safe” schools into which they’re certain to gain admittance, and then concentrate mainly on good “match” schools.

During one of the dozens of college tours my wife and I endured, an admissions officer at Emory University in Atlanta provided the most candor. “How do we decide between two A+ students who have equally impressive extracurriculars?” he rhetorically asked. “It’s the luck of the draw. Say, for example, our orchestra professor tells us that he needs a tuba player. That applicant might gain advantage over others who have higher grades and test scores. Or if we need less pre-meds and more liberal art candidates to keep a professor’s class full, then that applicant who checked he’s pre-med will lose out to the one that checked general liberal arts studies on her application. It varies year by year.”

I understand that this is hardly comforting to parents of current high school juniors and seniors. The pressure is on. We want the best for our children. And since it costs so much anyway, we want our kids to come out with a degree from an institution that will hopefully lead to gainful employment.

I’ve been trapped into that thinking for sure.

What’s the solution? There’s no easy one. I was talking to a parent of a current high school freshman who told his son not to enroll in the IB program. “I want him to enjoy high school. If he doesn’t get into the University of Florida or some other highly ranked state school, I’m okay with that. It’s what you do after college that’s important.”

Maybe we need more parents like that.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.

Homestead Problems

Tony owned a home on Sanibel for several years before claiming Florida residency. He was a resident of New Jersey, but he noticed the tax savings were worth the change of residency status. Twelve years ago, when he and his wife Carmela last updated their estate plan, they created New Jersey-based trusts. When Tony died last year, the trusts were not up-to-date with Florida law.

Back when they last completed their planning, the New Jersey attorney told Tony to put the Sanibel home into his trust to use against his estate tax exemption. At Tony’s death, his trust was to be held for Carmela for the remainder of her life, with Carmela as the trustee and the primary beneficiary.

When Tony died, Carmela was surprised to learn that the devise of the Sanibel residence, which was now their primary residence, was invalid under Florida law. Under Florida law, absent a nuptial agreement to the contrary, one must leave their home to his or her spouse. A devise into a trust, even for that spouse’s benefit, is invalid.

Once there’s an invalid devise, Florida law does not consider what Tony’s trust says about who should now own and enjoy the home. Instead, Carmela, as the surviving spouse, may choose between a “life estate” interest or half of the home as a Tenants-in-Common interest. The decedent’s children, in this case their son Anthony and daughter Meadow, take the remainder.

In other words, Anthony and Meadow have current vested ownership in the residence. The only fact that changed relative to the Sanibel residence between the time that Tony and Carmela prepared their New Jersey estate plan and the time of their death was that they became Florida residents. Yet, the disposition of the home changed dramatically because Florida law regarding the descent and devise of the home now applied.

Many attorneys up north do not recognize the nuances of Florida law, and they commonly instruct their clients that the estate plan drafted in the northern state is “just fine.” This is bad advice. While the will and trust remain valid if properly signed in another state in accordance with that state’s laws, the disposition of the assets may be different because of Florida law.

This is especially true when one owns a Florida homestead residence, as evidenced by Tony and Carmela’s dilemma.

Due to this invalid devise, Anthony and Meadow can prevent Carmela from selling the Sanibel residence. They need to sign off on any contract of sale and must sign a deed to a buyer. Anthony and Meadow are also entitled to a portion of the sales proceeds. If either Anthony or Meadow go through a divorce or have creditor problems, this may affect the title to the residence.

These problems are difficult enough to navigate when the children of the decedent are also the children of the surviving spouse. When step-relations are involved, however, it can become a completely different and oftentimes more adversarial process.

If you’ve become a Florida resident, whether you claim homestead status on your primary residence or not, these descent and devise laws apply.

I’ve been practicing estate planning law for 29 years here in Southwest Florida, and am a board-certified specialist in wills, trusts and estates. Most of the clients that I visit with already have estate plans that were drafted in their former state of residence, and the invalid devise of the homestead is a common issue that I find in many of the plans that come across my desk.

I’ll admit my frustration at my colleagues up north who tell their clients that their “wills and trusts are perfectly valid in Florida.” Yes, they’re valid, but they may have unintended consequences. That’s why it’s important to update your documents to Florida law when you become a Florida resident. The Florida homestead is just one issue. There are several more, for example, with a Durable Power of Attorney.

Carmela was fortunate that Anthony and Meadow cooperated to quit claim their interests back to Meadow. While those are “taxable gifts” requiring the filing of a Federal Gift Tax Return 709 (and consumed a portion of each of their lifetime exemptions from federal gift and estate tax), neither Anthony or Meadow have an estate that is likely to be taxable, so the problems were resolved.

It’s always better to head off those problems in the first place. If you’re a homeowner and have become a Florida resident or are considering Florida residency, have an estate planning specialist review your plan for these and other common problems.

© 2019 Craig R. Hersch. Originally published in the Sanibel Island Sun.