Estate taxes, also referred to as death taxes, relate to "power to transmit or the transition or receipt of property by death." Estate taxes are imposed when property is transferred at death. The size of the estate depends on the graduation of the tax. Estate tax consists of "an accounting of everything you own or have certain interest in at the date of death. The fair market value of these items is used, not necessarily what you paid for them or what their values were when you acquired them." (IRS.gov 1) "Gross estate" is what all of these items total to be. Property included in estate taxes could consist of real estate, annuities, securities, cash, insurance, business interest, trusts, and any other assets.
. Once gross estate is accounted for, there are deductions and reductions in value that may occur, which will result in the adjusted or "taxable estate." Deductions made to the gross estate could include "estate administration expenses, mortgages and other debts, property that passes to surviving spouses, and qualified charities. The value of some operating business interest or farms may be reduced for estates that qualify." (IRS.gov 2) After the taxable estate amount is computed, taxable gift lifetime value and net amount are added together to calculate the tax. Unified credit available reduces this tax. Publicly traded securities, cash, small assets, jointly held property, and no special deductions do not need an estate tax return to be filed. Estate tax returns, however, must be filed for estates with gross assets combined and gifts that are taxable exceeding "1.5 million dollars in 2004-05, two million in 06-08, 3.5 million for decedents dying in 09, and 5 million or more for decedents dying in 2010-11, 5.12 million in 2012, and 5.25 million in 2013."(IRS.gov)
Even in seven hundred B.C., ancient Egypt had people who at death would transfer property based on taxation. The past ninety years, estate tax laws have seen significant changes. No matter what the changes have been, the federal government has always relied on taxes of all kinds to provide government funding. The goal for this research paper is to explain the history of estate tax rates and propose predictions of future estate tax rates.
Estate taxes have been around for a long time. It was very popular in mid evil times when kings required heirs to pay estate tax to receive transferred property. In the seventeenth and eighteenth century Europe, there was much argument about whether or not property transfer was a "natural right" for people upon death. It was not until the eighteenth century that the government labeled property tax transfers as "not natural" then placing taxes on property transfers.
In the United States, the first effort that was made to try estate property tax was in the 1797 Stamp Act. This act stated that any document pertained to property, like a will, was entitled to a tax. The Stamp Act was brought about as the government’s attempt to aid funding for the war against France. During this time "taxes were levied as follows: ten cents on the inventories of the effects of deceased persons and fifty cents on the probate of wills and letters of administration. The tax on the receipt of legacies was levied on the bequest larger than fifty dollars from which widows, children, and grandchildren were exempt." The Stamp Act was ended in 1802 when the war ended.
When the Civil War came about in 1862, so did the return of estate transfer tax. During the war, not only were documents taxed, also the deceased person’s estate itself was taxed. This act differed from the previous Stamp Act because this tax package included inheritance tax along with the stamp tax. During this time, estates were exempt if they were less than one thousand dollars. Military expenses were rising in 1864, so congress introduced the gift tax. Gift taxes were taxes on property transfers that occurred during a person’s lifetime. When the Civil War ended, these taxes ended as well.
The United States discovered it needed more funding in 1898 when the Spanish-American War began, so estate taxes were re-implemented. Unlike the other two acts, the proposal of 1898 struck up much debate. Taxation was applied to personal property and legacy tax was made law. Small estates were excluded from the tax with a ten thousand dollar exemption. "In 1901, certain gifts were exempt from tax including gifts to charitable, religious, literary, and educational organizations and gifts to organizations dedicated to the encouragement of the arts and the prevention of cruelty of children."(IRS.gov 3) This war ended in 1902 and the tax was repealed. This tax alone raised over fourteen million dollars.
During World War I, 1916 estate tax and gift tax were favored by the president during that time; however, they also introduced income tax. When WWI ended, these taxes were never repealed. In the history of the United States and other countries, there is evidence showing a direct correlation between a country at war and implementation of taxes. Throughout 1916 and1948 there were significant changes to tax laws. In 1932, the first major change was the addition of taxes on gifts. Taxes on gifts became permanent in the federal tax system in 1932. The reason this tax came about was because congress realized estate taxes could be avoided by wealthy individuals by transferring wealth while they were still alive. The rules of 1932 state that fifty thousand dollars could be transferred free of tax during a donor’s lifetime with an annual exclusion of five thousand dollars per each recipient. An optional valuation date election was put in place through the Revenue Act of 1935. This allowed the assets of the deceased estate to be valued up to one year after their death. With economic events, such as the Great Depression, this would help citizens avoid estate taxes tremendously. In 1948, another revenue act was introduced. This act established the marital deduction of estate and gift taxes. This act allowed the surviving spouse receiving property of the estate to deduct the value of the property they received. This deduction did, however, have its limits. For instance, only one half of the deceased’s estate was allowed.
The next big change in the transfer tax system occurred in 1976 with the Tax Reform Act also known as TRA. "This act created a unified estate and gift tax framework that consisted of a single graduated rate of tax and posed on both lifetime gifts and testamentary dispositions. Prior to the act, it cost substantially more to leave property at death than to give it away during life. Due to the lower tax rate applied to gifts. The tax Reform Act of 1976 also merged the estate tax exclusion and the lifetime gift tax exclusion into a single unified estate and gift tax credit which may be used to offset gift tax liability during the donor’s lifetime, but which if unused at death is available to offset the deceased donor’s estate tax liability." (IRS 122) At this time, each recipient of an annual gift was limited to three thousand dollars per year.
Generation-skipping transfer trusts (GST’s), had a tax introduced with the 1976 tax reform package. Overall the GST tax insures that the transmission of hereditary wealth is taxed at each generation level. Generation skipping trusts is an agreement that is legally binding where assets contributed are passed down to grandchildren instead of children. By skipping the generation, and the opportunity to receive assets, the child is also avoiding the taxes that come along with the estate. Generation skipping trusts could still however benefit the child of the grantor because if any of the trusts’ assets generate income, that income can be made available for the grantor’s child even when the trust is left for the grandchildren.
In 1981, several new changes were brought to estate tax law through The Economic Recovery Tax Act (ERTA) of 1981. This act allowed for life interest deductions for spouses that were not terminable. (IRS 123)
Estate taxes were a big issue in Washington’s "fiscal cliff" deal in early January 2013. On January 1, 2013, the Senate passed the American Taxpayer Relief Act 2012. There were Considerations of this act that went towards estate taxes. The twenty thirteen federal agreement stated exemption levels for gift generation and estate transfer taxes set the lifetime level at five million dollars. This act also makes estate and gift tax unification permanent and for both there is a single graduated rate. This act provides the allowance of continued portability exclusion between spouses for a lifetime. The American Tax Payer Act also changed the estate tax rate from 35 to 40% tops. The current administration is pushing for wealthy people to pay their fair share, and estate taxes were mentioned frequently to achieve this. Going in to 2013, the estate tax rate, along with the exemption amount, was up in the air. Many democrats pushed for the exemption amount to be as low as one million dollars and with a 55% rate. With the exemption amount being that low and the rate being that high, estate taxes would bring in massive amounts of revenue for the federal government. After a decade of tax uncertainness, this new act restores clarity to gift and estate tax policy and provides certainty for financial planners to implement feasible estate and gift tax plans that will be reliable for the next few years.
Although the fiscal cliff is in the past, the changes to estate taxes are not set in stone. For 2013, the exemption amount is $5.25 million and is indexed for inflation. These changes leave many questions for people, especially those currently getting their affairs in order. One question they may have is whether or not their spouse has to pay estate taxes when they inherit from one another. The new law provides unlimited deduction on assets inherited by a spouse until the second spouse passes. This deduction only applies to spouses that are citizens of the United States. The second spouse does have the ability to pass assets down tax free to an extent, however. Widows and widowers have the ability to add together any un-used assets which will allow for a together transfer of up to $10.5 million tax free. This is known as portability. Executers of estates are responsible for portability because it is not an automatic process. Unused assets are passed to the survivor and can in turn make them assets that pass through his or her estate or make them lifetime gifts. There are a few prerequisites for this to happen. Estate tax returns must be filed upon the death of the first spouse, even if nothing is owed. The due date for this tax return is within nine months after a death; however there is a six month extension period. The right of portability is lost by the spouse if the executor of the estate fails to file a tax return or does not meet the deadline. It is recommended that all spouses file tax returns like these, even if they are not wealthy today, solely because the future of these taxes is unknown. (Forbes 1)
Lifetime gift and estate taxes are directly related, because they are expressed as a total amount. The current limit on the transfer of assets is $5.25 million for 2013, as stated earlier. The combination of the two must be less than the exemption amount, or the heir will owe up to a 40% tax. It is important that people keep up with how much of these have already been used so the Internal Revenue Service will know when you die. This also provides couples a break by process of gift splitting. By sharing during their lifetime, and giving more to their children during that time, it is tax free; however, that will also reduce how much of the tax-free is available when they pass. (Forbes 2)
With the likely hood of the exemption amount to be reduced dramatically in the near future, estate planning is a must. When it comes to future estate tax rates, it is all speculation. Although the laws in place for 2013 are supposedly "permanent," that could easily change depending on the country’s leadership in Washington. The current exemption amount and rate could possibly be permanent, but more regulation may be placed on trusts and other tools to expose more of the population to the tax. Although there are states that do not have any kind of estate taxes, this could change also, with the growing spending problem.
The prediction previously stated about the future of estate taxes was based solely on opinion; however there is plenty of information to back it up. The new federal budget President Obama has put in to place recently had a budget to raise estate taxes. This proposal the president made would change the tax rates in 2018 back to the 2009 levels. This change would dramatically increase the number of families that will have to deal with estate taxes. With changing the rates to the 2009 levels, it is estimated that of every one thousand people, about three would now be subject to the tax. Over a ten year period, this would raise about $79 billion in extra revenue. These changes would cause the exemption rate per person to drop from $5.25 million to $3.5 million this year. This would also change the top tax rate from 40 percent to 45 percent.
"As part of the end of year ‘fiscal cliff’ agreement, congressional Republicans insisted on permanently cutting the estate tax below those levels, providing tax cuts averaging $1 million per estate to the very wealthiest Americans," the white House said in its budget. "It would also eliminate a number of loopholes that currently allow wealthy individuals to use sophisticated tax planning to reduce their estate tax liability." (Washington Times 1)
The chart below is basically a simple timeline of the estate tax exemptions and rates in the United States. The time that is listed on this chart starts when estate taxes were enacted in 1916. There were many estate tax law changes that were significant for 1916 until the present time. In 1918, there was an expansion in tax base which included how married citizens divided their joint property, implemented general powers of appointment, and dealt with $40000 payable to estate of life insurance, and also deductions for charities were added. In 1924, the establishment of gift taxes began. There was also an addition of state death tax credit and "revocable transfers included in tax base." In 1926 there was a repeal of the gift tax. In 1932, the gift tax was reinstated. In 1935, citizens were now able to use an alternate valuation of their property at death. In 1942, there was an expansion of the tax base, which included decedent, paid for all insurance, most powers of appointment, and community property minus the actual contribution of cost of the spouse. The community property rules of 1942 replaced marital deduction in 1948. In 1951, the power of appointment rule was relaxed. In 1954, there was a modification of life insurance rules which excluded insurance never owned by the decedent. Unified estate and gift taxes came about in 1976. There was also the addition of orphan deduction, generation skipping transfer tax, and carry over basis rule and special rules were implemented for small businesses and farms. There was also an increase deduction for people who were married. The carry over rule was repealed in 1980. In 1981, marital deduction was made unlimited. During this time, there was also a change in the tax base, full value pension benefits, with one half of the joint property excluded automatically. There was also the orphan deduction repeal. In 1986, the generation skipping tax was modified and the ESOP deduction was added. "In 1987, the phase out of graduated rates and unified credit for estates over $10 million introduced." In 1988, QTIP permitted for marital deduction and the generation skipping tax was modified again. There was also an estate freeze introduced. In 1990, the freeze rules on estates were replaced. In 1997, there was a business deduction for qualified family owned businesses, there was an introduction of conservation easement, and the phase out of 1987 was revoked. In 2001, the Economic Growth and Tax Relief Reconciliation Act was instated. As seen above, it is clear that estate taxes have been anything but consistent.
I personally believe there will be more emphasis placed on federal estate taxes in the future to combat the government’s spending problem. If the current views of office remain the same in Washington, more revenue will definitely be needed, and will more than likely come from taxing the wealthier citizens of America. If the exemption amount ever drops to recently proposed $1 million, the amount of people required to pay the tax increases dramatically.
If Washington does not implement lower exemption amounts and higher tax rates, I believe they will try to regulate the ways people lower their estate amount to avoid estate taxes. For 2013, the maximum annual gift can be fourteen thousand dollars, tax free. Expect this to drop down sharply or almost disappear.
"Estate Tax." IRS.gov. N.p., 9 Mar. 2013. Web. 8 Apr. 2013.
Jacobs, Deborah L. "After The Fiscal Cliff Deal: Estate And Gift Tax Explained." Forbes. Forbes Magazine, 02 Jan. 2013. Web. 14 Apr. 2013.
Boyer, Dave. "Obama Budget Resurrects the Estate Tax." The Washingtion Times. N.p., 10 Apr. 2013. Web. 14 Apr. 2013.