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Inheritance tax planning with uncertain future payroll expenses: an analytical solution to the optimal choice between full and standard exemption

Author

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  • Markus Diller

    (University of Passau)

  • Thomas Späth

    (University of Passau)

  • Johannes Lorenz

    (University of Passau)

Abstract

Under the German Inheritance Tax and Gift Tax Act, the transfer of business assets can be exempted from taxation up to 100%. However, this exemption depends on the evolution of the company’s payroll, which is highly uncertain. We model the uncertain nature of payroll evolution using a Geometric Brownian motion. We obtain closed-form solutions for the expected effective exemption and for the expected effective tax rate. We find that the uncertainty effect is most pronounced for moderate negative and positive growth rates. Furthermore, higher uncertainty reduces the value of the effective tax exemption. Also, we find that the (partially progressive) German inheritance tax function by trend promotes standard exemption. The results enable tax planners to make an optimal choice between standard or full exemption and allow for calculating the expected tax burden.

Suggested Citation

  • Markus Diller & Thomas Späth & Johannes Lorenz, 2019. "Inheritance tax planning with uncertain future payroll expenses: an analytical solution to the optimal choice between full and standard exemption," Journal of Business Economics, Springer, vol. 89(5), pages 599-626, July.
    • Handle: RePEc:spr:jbecon:v:89:y:2019:i:5:d:10.1007_s11573-019-00929-2
    DOI: 10.1007/s11573-019-00929-2
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    References listed on IDEAS

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    1. R. A. Musgrave & Tun Thin, 1948. "Income Tax Progression, 1929-48," Journal of Political Economy, University of Chicago Press, vol. 56(6), pages 498-498.
    2. Turnbull, Stuart M. & Wakeman, Lee Macdonald, 1991. "A Quick Algorithm for Pricing European Average Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 26(3), pages 377-389, September.
    3. Benedikt Franke & Dirk Simons & Dennis Voeller, 2016. "Who benefits from the preferential treatment of business property under the German inheritance tax?," Journal of Business Economics, Springer, vol. 86(9), pages 997-1041, December.
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    Cited by:

    1. Rainer Niemann & Mariana Sailer, 2023. "Is analytical tax research alive and kicking? Insights from 2000 until 2022," Journal of Business Economics, Springer, vol. 93(6), pages 1149-1212, August.

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    More about this item

    Keywords

    Inheritance tax; Preferential tax treatment; Brownian motion;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • H30 - Public Economics - - Fiscal Policies and Behavior of Economic Agents - - - General
    • K34 - Law and Economics - - Other Substantive Areas of Law - - - Tax Law

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