Thursday, September 23, 2010

A Death Tax Tale

Once upon a time there was a company. This company was founded during the Great Depression, and survived that turmoil and the World War that followed it. In the 1960s it was bought by a pair of entrepreneurs who thought they could make it even better. And they did. Under their ownership it prospered. Eventually one of these owners died and his family's share was bought back by the company. That was costly, but the company survived it. The company survived other hardships as well: legal troubles, financial market struggles, moves, new products.

The company has been run by this family of entrepreneurs for nearly fifty years now. And after all of this history, it has been forced to sell itself. Why? Has the company been poorly run? Is it drowning in debt and has to find a partner to help pay its creditors?

No. The company generates millions of dollars in profits a year. It has no debt.

What is happening is simple: the second of the pair who acquired the company is aging, and so is his wife. At some point - maybe tomorrow, maybe ten years from now - they will be dead, and the estate tax will kick in. And if that happened, the company would basically be out of business, because while it is a cash cow, it doesn't have the funds to buy back enough stock to allow the family to pay those taxes. Furthermore, such buybacks would radically change the capital structure of the company, with the family possibly losing control. And all for no good reason.

Naturally, the company wants to avoid this outcome. So it is being acquired. The family and the minority shareholders get their payoffs now, and the company will be absorbed by its new partner. While the company has been lucky - the partner has pledged to run the company as a stand-alone operation, and not mess with its corporate operations or culture - they will install a new CEO, and inevitably some changes will be coming. Employees are nervous, and rightly so.

This is the sort of unintended, and injurious, consequence that Republicans talk about when they attack the "death tax." To make matters worse, in this case at least, the government won't even collect the tax. The acquisition will trigger some capital-gains taxable events (I assume - it may even manage to avoid those depending on the specifics of the deal), but those will be timed to coincide with current lower capital-gains tax rates. The 55% estate tax that will go into effect in 2011 (barring new legislation to prevent the sunsetting of the 2001 Bush tax cuts) will collect zero revenues from the company. It's hard to find a purer example of the Laffer curve at work.

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