Estate Tax Fear Is the Bad Part of Good Times

WASHINGTON —  Ira Cohen still doesn’t think of himself as a millionaire, but, as he discovered a few months ago, it doesn’t take that much these days for your assets to add up--big time.

The two-story tract house he owns in Glendora was worth several hundred thousand dollars. Thanks partly to the stock-market boom, there was a surprising several hundred thousand more in his 401(k) accounts. And he bought a vacation lot in Tucson that has appreciated in value.

His total net worth: $1 million-plus.

That realization spurred Cohen to set up a series of trusts to protect his children and grandchildren from the federal estate tax. Although the first $650,000 of an estate is effectively exempt from the tax, he was not taking any chances with his portfolio.

“The fact that my estate came to more than $1 million was a real shocker,” Cohen said.

Cohen’s paper fortune--and his anxiety about the estate tax--are part of a trend. Especially in Southern California, where house prices are high, many middle-income families are finding that their net worth has climbed to unexpected heights, making them millionaires on paper.

Partly as a result, some analysts believe, the Republican-led effort to repeal the estate tax--part of the massive tax-relief bill that Congress just passed--may be resonating beyond the narrow segment of rich GOP faithful who traditionally have worried about its effect.

Although statistics do not reflect it yet--Treasury Department figures show that only about 2% of the estates of Americans who die this year are likely to be dunned for estate taxes--planners say that today’s good times are making more families vulnerable to estate tax levies.

“We have more and more middle-class people coming in all the time--even machine shop workers--who find that they’re approaching millionaire status and they’re worried about the estate tax,” said Rusty Tweed, the San Marino estate planner who is handling Cohen’s trust.

Peter J. Davis Jr., a Washington-based tax policy analyst, agreed. “There’s been a huge creation of wealth over the past several years, and people who never used to think of themselves as rich are now being told: ‘You’ve got a big estate tax problem.’ ”

Estate planners say there are several factors behind the phenomenon:

* In many areas--Southern California, New England and Washington, D.C., among them--home prices have soared, often to $300,000 or more for a conspicuously modest house. In these areas, homes that would sell for $120,000 in the Midwest can easily bring $600,000 or more.

* New financial instruments, such as 401(k) accounts and tax-deferred individual retirement accounts, have helped workers accumulate large sums of money that will become part of their estates unless they spend it all after retiring.

* The last few years’ stock market boom has pushed the value of many 401(k)s, IRAs and other investments far higher than most analysts expected, often doubling or even quadrupling workers’ retirement portfolios over several years.

* The explosion of high-paying high-technology jobs, often replete with lucrative stock options, has thrust large segments of younger workers into comfortable positions, producing more paper millionaires--at relatively tender ages--than had been the case in previous years.

* With social patterns changing, many couples are in second marriages in which one spouse--or both--comes into the arrangement with a sizable portfolio of stocks or real estate. When the two are combined, the total often is substantial.

Despite these changes, Congress’ nonpartisan Joint Committee on Taxation estimates that only about 49,200 estate tax returns filed this year actually will incur tax liability, a figure that represents just 4.5% of all adult deaths.

Indeed, the Institute for Taxation and Economic Policy figures that 91% of the benefits from eliminating the estate tax, as the Republicans are proposing, would go to taxpayers in the top 1% of the income spectrum: those with incomes exceeding $300,000 a year.

Moreover, Congress already has passed legislation that would steadily raise the amount of a person’s net worth that is exempt from federal estate taxes to $1 million in 2006, and the law provides a spate of loopholes to escape taxation on the rest.

But figures published by the Federal Reserve Board show that, thanks largely to 401(k) accounts and other new financial instruments, many Americans are accumulating big increases in net worth that easily could push them well over those limits in coming years.

The Fed’s survey of consumer finances, its broadest measure of wealth, shows that in 1995, when the most recent count was taken, Americans owned significantly more stock than in the early 1990s and their assets were growing rapidly. Analysts said that the trend has accelerated since then.

Moreover, while public opinion surveys show that most Americans are indifferent about the GOP push for tax relief, anecdotal evidence from lawyers, planners and accountants suggests that the polls may be missing much of ordinary Americans’ concern over the estate tax.

Mike Janko, director of the National Assn. of Financial and Estate Planning, said that so many more people are worried about estate taxes now that he is beginning to question the figures on how small the effect is. “I’m guessing that those numbers are low.”

But William W. Beach, an analyst at the conservative Heritage Foundation, suggested that there may be a good reason why the public’s anxiety about the estate tax may be higher than the figures on its actual effect would suggest.

Although it is relatively easy for ordinary taxpayers to shelter their estates from the tax--through trusts or financial devices--most Americans are not aware of these methods until they are told about them by professional financial advisors, he said. As a result, the estate tax’s bark usually is worse than its bite.

Even so, the controversy over the estate tax is increasing steadily.

Beach and other conservatives argued that the levy, imposed in 1916, hurts the economy by discouraging savings and preventing family farmers and small-business owners from passing on their operations to their heirs.

By contrast, liberals argue that, for all the clamor by Republicans, the bulk of the tax is paid by a small group of very large estates, which otherwise likely would escape taxes on capital gains, tax-deferred savings accounts and other assets.

Moreover, they point out, while the estate tax only pulls in about 1.4% of the government’s total revenue, eliminating it would drain more than $330 billion from federal coffers over a decade--about a third of the tax relief contained in the tax cut bill that Congress passed.

At the same time, Congress already has moved to lessen the burden on farmers and small-business owners, passing legislation in 1997 that increased the exemption for such estates to $1.3 million.

Under current law, the “death” tax, as Republicans have dubbed it disparagingly, is levied on the market value of a taxpayer’s net worth at the time he or she dies. The first $650,000 of an estate effectively is exempt from taxation. The rates at which the taxes are levied follow a sliding schedule, much as rates for income taxes do, beginning at 37%--after the exemption--and rising to 55% for the portion of an estate above $3 million.

Many states also impose estate and gift taxes of their own, often paralleling the federal formula.

The estate tax in the United States has a colorful past, partly reflecting the country’s divided views on wealth: While Americans traditionally have disdained aristocrats and robber barons, most people seem to want to get rich themselves.

The United States did not even have a permanent income tax until 1914, and it was not until 1916 that Congress approved the first taxes on the transfer of wealth--the forerunner of today’s estate tax. It was intended primarily to finance participation in World War I.

The estate tax became more popular when, in the early 1930s, President Franklin D. Roosevelt portrayed it as a way to break up the concentration of wealth in the nation’s richest families. Since then it has become increasingly complex.

Republicans, particularly in the House, have made it a signature issue for several years, writing its repeal into the tax bill that lawmakers passed before their August recess. President Clinton has threatened to veto the legislation, so its outlook is uncertain.

After the expected veto, Clinton is likely to begin a series of intense negotiations with GOP congressional leaders on a wide range of tax and spending issues, including the estate tax repeal.

Jay A. Soled, a Rutgers University tax expert, said that some of the political sting of the estate tax could be reduced if lawmakers would trim the rates at which the estate tax is levied and make it more progressive so that it hits taxpayers more evenly than now.

Meanwhile, Ira Cohen, now retired and living in Tucson, is satisfied that the steps he has taken to protect his new millionaire status will keep the tax collector sufficiently at bay. Now, he said, with a chuckle, “my goal is to spend as much of it as I can.”