If you are an American citizen with hundreds of millions of dollars in assets, this would be a great time to die. No disrespect intended. It’s just a fact. For seldom have there existed better conditions for transferring vast fortunes to one’s offspring.
A married couple can now leave a total of $23.4 million to the kids without paying a dime in federal estate or capital gains taxes. That’s the highest exemption level in decades, not counting a temporary repeal of the estate tax in 2010. And the opportunities to sidestep inheritance taxes are legion. So much so that when Goldman Sachs alum Gary Cohn, then an adviser to President Donald Trump, kicked a hornet’s nest by reportedly joking that “only morons pay the estate tax,” wealth professionals around the country were no doubt nodding in agreement. (One Cohn defender explained that whatever he may have said, Cohn was merely alluding to rich folks who don’t take advantage of rigorous tax planning.)
America’s ultrawealthy already get away with murder by structuring their finances to avoid income, and therefore income taxes. It’s not rocket science. Anybody with a large trove of invested assets can use those assets as collateral for low-interest loans to fund their lavish lifestyles. Voila! No income. That’s a lot cheaper than selling off chunks of stock, for example, and paying tax on the gains.
The top income tax rate these days is 37 percent, but as ProPublica revealed in a bombshell report this week, megawealthy fellows like Jeff Bezos, Michael Bloomberg, Warren Buffet, Carl Icahn, and Elon Musk pay a few percent at most. The situation is equally bad—or good, depending on your perch—with gift and inheritance taxes, which max out at 40 percent. Those taxes, if properly imposed and collected, would help narrow our yawning wealth gap and perhaps limit the toxic influence of dynasties in the political process. But, as Cohn intimated, they are easy to beat.
In a comprehensive 2020 analysis, Lily Batchelder, a tax policy expert at the New York University School of Law who is awaiting Senate confirmation as assistant treasury secretary, writes that the effective tax rate on inheritances is a piddling 2.1 percent, “less than one-seventh the average tax rate on income from work and savings.” She points out, too, that Americans were projected to inherit some $765 billion in gifts and bequests last year, and that a large share of all US wealth—about 40 percent—is derived from inheritances. “Despite our national mythos as a land of opportunity,” Batchelder writes, “the United States also has one of the lowest levels of intergenerational economic mobility. That is, relative to other countries, financial success in the United States depends heavily on the circumstances of one’s birth.”
It may seem odd, given the success of the superwealthy in legally avoiding inheritance taxes, that America’s dynasties seem so desperate to dispense with them. In 2015, Public Citizen identified nine billionaire families lobbying actively for estate tax repeal. From 2012 through early 2015, the nonprofit reported, the Mars (candy) and Wegman (grocery) dynasties, together worth more than $137 billion combined, had spent more than $3.5 million on repeal. Other dynasties (Bass, Cox, DeVos and Van Andel, Hall, Schwab, and Taylor) spent a total of $7 million lobbying on this and other issues. The US Chamber of Commerce, according to public disclosures, also lobbies regularly for repeal of the “death tax.”
Since 2011, House Republicans have introduced at least 44 bills to kill the estate tax and the generation-skipping transfer tax, enacted to prevent wealthy families from bypassing a round or two of estate tax by passing large fortunes directly to grandchildren and great-grandchildren. The lobbying efforts noted above, though unsuccessful in their primary goal, appear to have paid off handsomely. As part of the roughly $2 trillion tax-cut package President Trump signed into law in December 2017, Republican lawmakers unilaterally—albeit temporarily—doubled the limit on how much money elite families could pass to their heirs in life and death without paying a tax.
That lifetime exemption, as of 2021, is $11.7 million for an individual and $23.4 million for a married couple. So if my wife and I had $30 million—we do not—we could leave the majority to our kids tax free. Thanks to the “step-up in basis” (or “stepped-up basis”) rule, the values of our invested assets—stocks, artwork, real estate—would reset to their current fair market value when we die. Our heirs could then sell all those inherited assets and not pay a cent on the unrealized profits we accrued during our lifetimes—profits that would ordinarily be subject to a 20 percent capital gains tax.
Levies on the post-mortem transfer of propertyoriginated in Egypt around 700 BC, according to an IRS history. They were later imposed, around the time of Christ, by the Roman emperor Caesar Augustus, and then by feudal lords in Europe. America’s first death tax—that’s what it was officially called—was imposed as part of the Stamp Act of 1797 to cover the cost of US military skirmishes with France. The federal government charged 25 cents on postmortem bequests of $50 to $100, 50 cents on $100 to $500, and $1 on each additional $500.
Congress enacted a second round of death taxes in the Revenue Act of 1862 to raise funds for the Union to fight the Civil War. Lawmakers did so again in 1898 to bankroll the Spanish-American War. These taxes were not burdensome. In the latter case, if a wealthy man left behind $10 million—a staggering fortune—to a sibling, child, or grandchild, his estate owed the government just over 2 percent, about $219,000. All three taxes were repealed after the hostilities ceased.
By the late 1800s, however, America was transitioning rapidly from an agrarian economy to an industrial one. The old federal patchwork of tariffs and property taxes was leaving the fortunes of Gilded Age industrialists like Andrew Carnegie and John D. Rockefeller largely untouched. Reformers began calling upon the government to tax these “robber barons,” while the businessmen, as today, countered that such a move would stifle growth and quash innovation. The Revenue Act of 1916, in anticipation of the coming war effort, levied a tax of up to 10 percent on inheritances of $50,000 or more (about $1.1 million today); the levy was increased to 25 percent the following year, although it was later repealed. But Rockefeller never paid a penny. He just signed his fortune over to his son before he died, because Congress hadn’t yet passed a gift tax.
It wasn’t until 1976, after another six decades of tweaks, that Congress finally put in place a comprehensive, integrated gift-and-estate tax similar to what we have today. (The congressional Joint Committee on Taxation offers a detailed history.) America’s dynasties have been trying to get rid of it ever since. But the endless squabbling over the estate tax, which was expected to bring in just $16 billion last year, Batchelder writes, is largely a distraction from what’s really going on.
While researching my new book about wealth in America, I interviewed a woman—we’ll call her Jane—who had been hired to work in the family office of a retired Wall Street banker. Family offices are private companies created by extraordinarily wealthy families to manage their myriad investments, businesses, and personal affairs. The family’s primary focus, typical among dynasties, was to grow and protect its wealth with the goal of passing along as much of it as possible to the children and grandchildren. Jane recalls the patriarch one day saying something like, “‘If the government keeps taking our money, we’ll take our money elsewhere’—meaning offshore. I don’t know if he was super serious, but he was super pissed about the Affordable Care Act,” which placed a 3.8 percent surcharge on America’s highest earners. “In terms of tax avoidance,” Jane says, “they were all about the GRATs, and used to do GRITs.”
That’s not breakfast. GRITs are grantor retained income trusts, once a popular estate-tax dodge. GRITS were replaced by grantor retained annuity trusts, or GRATS. These are just two ingredients in an alphabet soup of legal instruments—GRUTs, CRATs, CRUTs, CLATs, CLUTs, QTIPs, QPRTs, SLATs, etc.—that estate lawyers for hyper-affluent families deploy to maximize intergenerational wealth transfer. GRATs are particularly handy when interest rates are low—namely, the federal 7520 interest rate, which averaged an unheard-of 0.61 percent during the first 12 months of the pandemic.
Here’s how they work—specifically “Walton GRATs,” the kind everyone uses. You have your lawyer set up the trust and assign a bunch of assets to it—that could be stocks, a Picasso painting, a stud racehorse, whatever. The initial value of the assets, plus interest calculated at the outset using that month’s 7520 interest rate, gets disbursed back to the trust’s creator in annual installments (annuities) over the lifetime of the trust, which can range from two years to much longer—that’s up to you. If the assets in your Walton GRAT increase in value faster than the 7520 rate would have predicted, there will be assets left over at the end of the trust’s lifetime. Those assets go to your beneficiaries—your princelings—tax free. Better yet, they don’t count against that lifetime gift/estate tax exemption.
To play this game effectively, you need an asset that’s not worth very much now, but is likely to explode in value—like an initial stake in a private equity partnership or shares of a pre-IPO stock. In 2008, Facebook co-founders Mark Zuckerberg and Dustin Moskovitz set up annuity trusts, presumably for the benefit of generations not yet born. Before Facebook went public at $38 a share, its SEC prospectus reveals (see the chart and footnotes on p. 127), Zuckerberg transferred more than 3.4 million shares (some purchased for as little as 6 cents apiece) into the Mark Zuckerberg 2008 Annuity Trust. Moskovitz did the same with 14.4 million shares, and Sheryl Sandberg, Facebook’s chief operating officer, socked away 1.9 million shares in her annuity trust.
The federal interest rate was higher then—averaging about 3.8 percent in 2008—but the value of Facebook’s stock took off sometime after its IPO in 2012. Had those executives created GRATs with 10-year terms (that detail is not publicly available), their heirs stood to receive hundreds of millions of dollars—perhaps billions—without paying a dime in federal taxes. According to a 2013 report by Bloomberg’s Zachary Mider, the late billionaire and Republican megadonor Sheldon Adelson used a series of short-term Walton GRATs to transfer nearly $8 billion to his heirs, thereby avoiding billions of dollars in gift taxes. Pair that strategy with highly volatile stocks, as Adelson reportedly did, and you won’t always win, but you literally cannot lose.
So how did this ridiculously lucrative strategy come to pass? Well, the federal government created it—by accident. I called up Richard Covey, the octogenarian tax attorney credited as the inventor of the “no-risk” (his words) Walton GRAT. Covey edits a newsletter called Practical Drafting for Bank of America’s wealth management division, US Trust. Most Americans would never read such a publication, but estate lawyers sure do.
Back in the 1980s, when interest rates were relatively high, wealthy families embraced another of Covey’s innovations, the aforementioned GRIT, as an estate-tax workaround. The GRIT was a fairly modest dodge that might save a rich family a few percentage points on gift taxes. But Congress decided to curb what the IRS had deemed an abusive tactic. So the lawmakers tweaked the rules in 1988 and 1990, and unwittingly created a monster. “They completely blew it,” Covey told me. “Instead of tightening up on the law, they loosened up on the law, and they didn’t know that!”
The new rules let families use a setup similar to another ultrawealthy tax boondoggle known as “charitable lead trusts”—the aforementioned CLATs and CLUTs. These trusts were nicknamed “Jackie O trusts,” because the former first lady famously used them to enrich her children while giving to charity at the same time. As Bloomberg’s Mider also reported, the Waltons—America’s wealthiest family, with combined assets of more than $234 billion—made ample use of Jackie O trusts to transfer huge sums to their offspring without paying any taxes. On the contrary, they were able to take charitable deductions.
Walton GRATs were deemed legit in 2000, when Covey successfully defended Audrey Walton, the sister-in-law of Walmart founder Sam Walton, against a challenge by the IRS. (He’d used the same strategy with other clients, he told me, but Walton was the one who got called out by the tax commissioner.) Since then, Walton GRATs have saved America’s dynasties untold billions.
If all of this was based on a mistake, I asked him, why hasn’t Congress fixed it? Well, Covey replied, to do that, you’d realistically need a Democratic trifecta: House, Senate, and Oval Office. And that had happened only twice since 1990—during the first two years of the Clinton and Obama administrations. (Our conversations took place prior to the 2020 election.) Once it became clear that Democrats would again have the trifecta, wealth advisers and white-shoe law firms began alerting wealthy clients that, should they feel inclined to set up trust vehicles that would lock in the current, generous rules of inheritance, this would be a fine time to do so.
But the superwealthy needn’t fret. With a razor-thin margin in the Senate, it’s not at all clear the Democrats will be able to rein in tax policies that favor that rarified crowd. Republican leaders have signaled, in no uncertain terms, that they won’t be on board with any rollbacks of the 2017 tax cuts. They oppose President Biden’s proposal to increase tax rates on long-term capital gains to match the rates workers pay on wages. And after years of gutting the ability of the IRS to pursue wealthy tax cheats, the Republicans intend to fight Biden’s plan to restore and enhance the tax agency’s enforcement budget.
So far, Biden has not targeted the estate-tax exemption, which is scheduled to reset to its pre-Trump level (half of the current level) in 2026, unless Congress extends it. He does, however, want to eliminate the stepped-up basis rule, a move that would compel heirs to pay capital gains taxes on their inherited assets past a certain threshold. But Batchelder, who, if confirmed by the full Senate, will be Biden’s top adviser on tax policy, aspires to fundamentally transform the way the government taxes inheritances.
She would repeal the gift and inheritance taxes, just as the Republicans have always wanted. Instead, she writes, “a wealthy heir would simply pay income and payroll taxes on their large inheritances, just as a police officer or teacher does on their wages.” Beyond a reasonable lifetime exemption, heirs would have to report inheritances as ordinary income, and would be expected to pay the same taxes the rest of us see on our pay stubs—including Social Security tax, which currently favors high earners because it maxes out once a person’s income hits $142,800.
Batchelder’s vision goes deeper, changing certain rules around complex trusts and family partnerships. With GRATs, for example, “the value of the heirs’ taxable inheritance would not be based on a rough projection of future events” calculated according to that 7520 interest rate, but rather on the real-life performance of the trust assets. In the meantime, the feds would charge a “withholding tax” on the trust at the maximum rate of about 50 percent. The Urban Brookings Tax Policy Center, she writes, calculates that the proposed reforms would raise an additional $340 billion over a decade if the lifetime exemption on inheritances is set at $2.5 million, and $917 billion if the exemption is $1 million.
Proposals so bold, an arrow in the heart of America’s aristocracy, are unlikely to be well received by America’s elite, or its wealth managers, who are compensated with a percentage of the assets they keep under management. The success of any big overhaul of the wealth-transfer system will almost certainly hinge on the results of the 2022 midterms, and even then, a stronger Democratic trifecta might not do the trick. More than half of the top 100 donors to federal candidates, parties, and PACs in the last election cycle, after all, gave primarily to Democrats. And chances are, they will have some strong opinions about all of this.