Inheritance tax debate: what wealthy people need to know

Rarely does a tax with so little financial impact generate as much argument as inheritance tax. In the developed world, it generates only 0.5 percent of total tax revenue in the countries in which it is levied, according to an OECD report. But it creates undue controversy, especially if there is a proposal to increase it – as is happening now as governments wonder how they are going to pay for the pandemic.

Some critics say that it is fundamentally unfair to tax people twice as IHT is levied on assets accumulated over the life of the income tax payment. Others say IHT is by no means unfair, but is a key tool in making the world a better place. They argue that the emergence of a super-rich elite is increasingly being fueled by inherited money.

As the OECD points out, there are many misunderstandings. The report cites a 2015 survey where respondents estimated that more than half of US families paid IHT. In truth, only 0.1 percent do it. Paying to die seems like something haunting – as many critics see inheritance tax – which tarnishes people’s judgment.

A long decline in wealth inequality has slowed, and even vice versa.  Chart showing the wealth share (%) of the top 10% and top 1% in South Korea, Germany, France, UK and USA

However, there are real problems to be solved. The report says that wealth inequality is increasing in most developed countries, and so is often the proportion of wealth that is passed down from generation to generation. This is especially true of the US, which, ironically, is based on the ideal of equal opportunities.

The very rich are more successful than others in reducing IHT. First of all, they are much more likely to use tax havens where IHT can be minimized. According to the OECD, the richest 0.01 percent of the people own 50 percent of the tax haven assets. But even without deception, the super-rich can protect their wealth by taking advantage of tax breaks that give those with tens of millions of dollars greater benefits than those who only have millions.

Many countries grant family business assets in whole or in part, and quite a few, for agricultural land, particularly the United Kingdom. Some also treat lifelong gifts favorably. The UK effective IHT rate for assets of £ 10 million and above is 10 percent, compared with 19.5 percent for assets of £ 8 to 9 million, the report said. You don’t have to be left to wonder if something strange is going on.

Tax Exemption Thresholds for Donor Children $, 2020. The US leads the way with a threshold of $ 11.58 million.  Belgium has the lowest value at just $ 17,000

The OECD says inheritance taxes are worth it, despite the bureaucracy, to increase revenue and improve equality. But it is right to call for reforms. It favors the taxation of recipients, as is the case in some EU countries, instead of the estate, as in the UK and USA. This is more equitable as the tax levied would reflect the situation of the (living) recipient and not the (dead) donor. The OECD also proposes to merge inheritance taxes and duties on gifts during lifetime in order to tax the recipients according to the money flow received over the years and not, somewhat arbitrarily, only in the event of death. As the authors acknowledge, lifetime levies are complex to manage and difficult to implement. They may enjoy the support they offer for cuts on IHT exemptions. They prefer a broad tax system with progressive tax rates and few loopholes so that the rich pay more than the others.

Gift taxes are even less payable to governments than inheritance taxes.  Diagram showing gift taxes as well as inheritance and inheritance taxes as a% of total tax revenue

The OECD recognizes political sensitivities. The dismantling of exemptions inevitably leads to criticism from the losers without necessarily being supported by those who are not affected. The answer, the report says, is to combine reforms with other changes that promote equity, such as cuts in labor taxes. Not to mention cracking down on evasion and unreasonable avoidance (again).

What are the conclusions for the rich? First, let your advisors study the report as there are deep political differences between countries. Or better yet, read it for yourself. Next, in the face of pandemic-induced national debt growth and government intervention around the world, including the US, prepare for higher tax systems.

The inherited fortune makes up half of the individual fortune.  Chart showing Inherited Wealth / Personal Wealth (%) for the United States, Sweden, Germany, the United Kingdom, and France

Lastly, for those running family businesses, you shouldn’t be obsessed with giving control to the kids. There may be better options for the business and family, especially if these exemptions are removed.

Stefan Wagstyl is editor of FT Wealth and FT Money. Follow him on Twitter

This article is part of FT Wealth, a section that goes into depth on philanthropy, entrepreneurs, family offices, and alternative and impact investments

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