In most years, only 0.3 percent of those who pass their estates to heirs upon their death end up leaving those heirs with a tax bill. Thanks to exceptions, credits, and thresholds, even the very wealthy can avoid the estate tax. This year is a special year, however. As of today and unless the law is changed, anyone who dies in 2010 is guaranteed to owe no federal estate taxes; this tax has been repealed for just this year.

Last year I considered whether this one-year break would encourage families to keep their loved ones on life support until January 1, 2010 or to encourage passing before January 1, 2011. I wasn’t the only one. A study from Columbia University found the following based on data from other estate tax law changes throughout the last century:

There is abundant evidence that some people will themselves to survive in order to live through a momentous event. Evidence from estate-tax returns suggests that some people will themselves to survive a bit longer if it will enrich their heirs. To be sure, the evidence is not overwhelming. Nevertheless, our central estimate is that, for individuals dying within two weeks of a tax reform, a $10,000 potential tax saving (using 2000 dollars) increases the probability of dying in the lower-tax regime by 1.6%. That there is any effect at all adds to the large body of evidence that taxes affect behavior, and particularly the timing of behavior, including activities such as marriage and childbearing, which are not generally thought to respond to financial incentives.

We cannot rule out that what we have uncovered is not a real death elasticity, but instead ex post doctoring of the reported date of death to save on taxes. Even in that case, this exercise provides evidence on how the attempt to collect taxes can engender resource-using avoidance responses that reduce tax revenue.

Changes in the law encourage people either to optimize time of death or to report death at the optimal time. This may not be the case for Dan L. Duncan, the first billionaire whose heirs will owe no estate taxes on their inheritance. Because Congress didn’t close this one-year reprieve, the Treasury stands to miss billions of dollars in income, some from Dan and some from other very wealthy individuals, that would have otherwise been collected.

Some charities and other non-profit organizations may feel a side-effect from this year’s exemption. Charitable giving is often a part of estate planning, and one goal of estate planning is to reduce tax liability. Charity has the benefit of being a good deed and sheltering wealth from taxes. If there are no estate taxes to avoid this year, there will certainly be estate planners who decide to pass all income to heirs rather than distributing wealth to needy organizations.

Legacy for One Billionaire: Death, but No Taxes, David Kocieniewski, New York Times, June 8, 2010

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If you are lucky enough to inherit (for example) $10 million in property or investments from deceased relatives, you are also lucky enough to pass a good portion of that to the government in the form of estate taxes. It is kind of a strange concept. Why should that money be taxed? It is simply a gift from one person to another, not a gift to the government. The basic argument in favor of the estate tax is that it helps to prevent massively wealthy families from avoiding tax on their main source of income, generation after generation. The existence of the estate tax also encourages charitable giving, as that is a way to avoid this particular tax.

Opponents of the estate tax often call it a “death tax” to stir emotions and create a political issue. Warren Buffet has is critical of the “death tax” term and is a strong supporter of the estate tax.

The billionaire investor has been an outspoken critic of efforts to repeal the estate tax and in testimony at a Senate Finance Committee estate tax hearing on Wednesday, he told lawmakers that you’d have to attend 200 funerals to be at one where the family of the deceased would owe estate tax.

So it sounds like the families that were intended to be taxes on their estates end up avoiding the tax while still passing along their wealth. Those who want to repeal the tax argue that it hurts farmers and family business owners whose property or business is passed down from one generation to the next, and need to sell part of their business to pay the bill.

Buffett provided suggestions for improvements to the estate tax that will ensure that those passing on their wealth fairly contribute to the government while protecting family-owned businesses.

File this under the category of “problems I’d like to have one day.”

Update: On Advanced Personal Finance, KMC explains why the estate tax is the most misunderstood tax.

Do you think the estate tax should be repealed?

Buffett: Phrase “Death Tax” is “Dead Wrong” [CNN Money]

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