WASHINGTON WATCH

BETH SHAPIRO KAUFMAN

On the Centennial Anniversary of the Estate Tax

his year we celebrate the 100th property relied on the army and tribution deduction. In 1924, Con - anniversary of the federal estate navy to protect their interests, while gress added a state death tax cred - T tax, the tax everyone loves to the poor had less to defend. it (equal to 80% of the federal tax!) hate. This is a good time to reflect Politicians also put forth eco - and also enacted a gift tax. 4 The gift on the history and purpose of the nomic arguments for the estate tax. tax got off to a rocky start: It was tax, the role it plays in our pro - On the verge of World War I, the repealed in 1926 5 after a mere two gressive tax system, and what the U.S. needed revenue. The income years in effect, and then reenacted future might hold for it. tax was already in effect. An estate in 1932. 6 The second time, it stuck. The modern federal estate tax tax was another way to raise rev - The gift tax was needed as a back - was enacted into law on 9/8/1916. 1 enue and add to the overall pro - stop to the estate tax, because, with - Although Congress had previous - gressivity of the tax system. out it, the estate tax could be avoid - ly imposed various tariffs on death, ed by making lifetime gifts. primarily to fund specific war Evolution of the estate tax After the harsh experience of the efforts, the exactments had all been The estate tax as enacted in 1916 stock market crash of 1929, Con - temporary. The circumstances that provided an exemption for the first gress in 1935 added an alternate led to the enactment of the modern $50,000 of wealth for residents, valuation date election. 7 As origi - estate tax in 1916 were unique in but no exemption for nonresidents nally enacted, the estate could opt the history of the U.S. First, the who owned U.S. property. The tax to use the value of assets one year boom in industrialization and man - rates ranged from 1% to 10%, after the decedent’s death if asset ufacturing led to concentrated with the 10% rate applying to values had declined. wealth in the hands of a small num - estates in excess of $5 million. In In 1948, a marital deduction was ber of businessmen. This was the 1917, the estate tax raised $6 mil - added to the estate tax for the first

era of Andrew Carnegie, John D. lion in revenue. time. 8 The marital deduction pro - Rockefeller, and , In the intervening 100 years, the vision allowed a deduction for up to name a few. President Theodore estate tax has been modified repeat - to one-half of a decedent’s adjust - Roosevelt advocated for an estate edly. The base was broadened in ed gross estate for property (other tax to address the growing inequal - 1918 to include exercised general than community property) passing ities in wealth in the U.S. In Roo - powers of appointment and life to a surviving spouse. This provi - sevelt’s words: “The man of great insurance payable to the estate. 3 sion was intended to level the play - wealth owes a peculiar obligation That act also added a charitable con - ing field between community prop - to the State because he derives spe - erty and non-community property cial advantages from the mere exis - BETH SHAPIRO KAUFMAN, of the District of states. A similar marital deduction Columbia and Maryland Bars, is a member and pres - tence of government.” 2 provision was also added to the gift As Roosevelt implied, there was ident of the law firm of Caplin & Drysdale, Chartered, tax. The concept of gift-splitting located in the firm’s Washington, D.C. office. She is a sense that the wealthy benefited was also introduced in 1948. also a Fellow of the American College of Trust and most from the stability provided by Estate Counsel, and has written and lectured exten - The next major changes to the the government. Those who owned sively on estate planning. estate tax occurred in 1976, when 38 39

the tax was 60 years old. The Tax From the Editor Reform Act of 1976 9 “unified” the estate and gift taxes, applying a sin - With the completion of this column, Beth Shapiro Kaufman is retiring gle exemption, to be used against from her position as the Washington Watch columnist for ESTATE PLANNING . either lifetime gifts or bequests, and Ms. Kaufman’s insights have been gracing our pages for the past decade. Over a single run up the brackets appli - this time, the scope of her coverage has been impressive, providing perspectives cable to both taxes. The annual on a wide range of estate planning issues arising in our nation’s capital. exclusion from gift tax was set at We appreciate her excellent work and wish her the best in future endeavors. $3,000. Special provisions were added to the Code to benefit farms and small businesses. The special- skips.” The tax applied at the time ple who are assigned to a genera - use valuation provisions allowed of the child’s death. tion only one below that of the property to be valued at its current- The Economic Recovery Tax Act donor and people who are more use value rather than its highest and of 1981 10 also introduced signifi - than one generation younger than best-use value. In addition, certain cant changes, most notably the the donor) and at the top marginal small businesses were allowed to unlimited marital deduction and rate of the estate tax. pay estate tax in installments to try the creation of qualified terminable By 1988, Congress had second to avoid the need to sell a closely interest trusts. Along with those thoughts about the unlimited mar - held business in order to raise funds changes, the Act also automatical - ital deduction for all spouses. Since to pay estate taxes. ly included in the estate one-half of the unlimited marital deduction acts The also property jointly owned with a as a tax deferral mechanism delay - included two important but ill-fated spouse, without regard to which ing the payment of estate taxes until provisions. First, the Act put into spouse contributed to purchase the the second spouse dies, Congress place a carryover basis system, cre - property. In addition, the annual feared that if non-citizen spouses ating a general rule that property exclusion from gift tax was remained eligible for the unlimited inherited from a decedent would increased to $10,000. marital deduction, they could leave keep the decedent’s basis in the The generation-skipping transfer the U.S. without paying any tax. To hands of the heir or legatee. After tax enacted in 1976 was retroac - eliminate that risk, Congress enact - postponement of the effective date tively repealed in 1986. 11 Lore has ed new legislation 12 denying the mar - for carryover basis, the provision it that the tax was so easy to avoid ital deduction when the surviving was finally repealed retroactively in that only a handful of taxpayers had spouse is not a U.S. citizen, but 1980, such that it never actually ever paid it, and the government allowing the estate tax to be deferred went into effect. Second, the Act refunded all of the tax that had ever if the assets are held for the benefit included the system’s first genera - been collected. Our current gener - of the surviving spouse in a “qual - tion-skipping transfer tax. This tax ation-skipping transfer tax was ified domestic trust.” applied to transfers that benefitted enacted in its place, differing from New Chapter 14 was added to the “child” generation without caus - its predecessor in that the tax applies the Code in 1990, 13 attacking pop - ing inclusion in the child’s estate to “direct skips” to the grandchild ular estate tax freeze techniques. (i.e., gifts in trust), but did not apply generation (as well as gifts in trust This legislation eliminated grantor to what we would now call “direct and gifts that benefit both the peo - retained income trusts, but codified grantor retained annuity trusts and grantor retained unitrusts, along 1 The , Act of September 9 The Tax Reform Act of 1976, P. L. 94-455, 94th with personal residence trusts. 8, 1916, 39 Stat. 756. Cong., 2nd Sess. (1976). 2 T. Roosevelt, State of the Union Address The Economic Recovery Act of 1981, P. L. 97- In 1997, Congress indexed sev - (12/3/1906). 10 34, 97th Cong., 1st Sess. (1981). eral important transfer tax param - 3 The , Act of February 24, 1919, 40 Stat. 1057. 11 The , P. L. 98-369, eters, including the annual exclu - 98th Cong., 2nd Sess. (1984). 4 The , Act of June 2, 1924, sion, the special-use valuation, and 43 Stat. 253. 12 The Technical and Miscellaneous Revenue the GST exemption, but notably 5 The , Act of February 26, Act of 1988, P. L. 100-647, 100th Cong., 1926, 44 Stat. 9. 2nd Sess. (1988). not including the exemption from The , Act of June 6, 47 6 The Omnibus Budget Reconciliation Act of estate and gift tax. Stat. 169. 13 14 1990, P. L. 101-508, 101th Cong., 2nd Sess. The , Act of August 30, The new century started off 7 (1990). 1935, 49 Stat. 1014. with the most successful bid yet 8 The , Act of April 2, 1948, 14 The Taxpayer Protection Act of 1997, P. L. 62 Stat. 110. 105-34, 105th Cong., 1st Sess. (1997). to repeal the estate tax. The 2001

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Act 15 called for the phase out and tion and “step up” in basis to the to 1931, and a brief decrease to repeal of the estate and GST taxes fair market value as of the date of $40,000 from 1935 to 1941, the (but kept the gift tax as a “backstop” death. For very large estates, how - exemption remained the same until to the ). Under applica - ever, it was often more advanta - 1942. In 1942, the exemption was ble budgetary rules, however, the leg - geous to elect out of the estate tax bumped up to $60,000, where it islation did not have a sufficient num - and accept carryover basis. remained through 1976. Finally, the ber of votes to allow it to have any The legislation passed at the end 1976 Act put into place annual budget impact beyond a ten-year of 2010 contained several other increases, which brought the exemp - window. That was the genesis of the taxpayer-favorable provisions. tion level up to $175,000 in 1981. one-year repeal of the estate tax for Congress left the $5 million estate Further legislation increased the 2010 only. As a trade off for hav - and GST tax exemptions in place exemption amount to $600,000 ing no estate tax, Congress also gen - for 2011 and 2012. Congress also over the period from 1981 through erally required carryover basis for increased the gift tax exemption to 1987, and legislation enacted in inherited property, with an allowance $5 million for those two years (it 1997 scheduled additional increas - of “additional basis” that could be had previously been held at $1 mil - es slated to bring the exemption allocated to assets held at death lion while the estate tax exemption up to $1 million in 2006. Howev - to increase their basis (but not increased over the period from er, the 2001 Act preempted the prior above fair market value on the date 2001 to 2009). Finally, the bill legislation and jumped the exemp - of death). added portability of the estate and tion level to $1 million in 2002, When the one-year repeal was gift tax exemption, so that if one while at the same time scheduling enacted in 2001, it was widely spouse did not use all or his or further increases up to $3.5 million

believed that Congress would enact her exemption at death, the remain - in 2009 and then repeal in 2010. 19 further legislation that would either ing portion could be transferred to To put these amounts into per - void the one-year repeal or make the surviving spouse for his or her spective, a $50,000 exemption in repeal permanent. Despite signifi - use against lifetime gifts or at death. 1916 would be a $1.15 million cant support for permanent repeal, The 2010 legislation also indexed exemption in 2016 dollars, while a however, other events intervened, the estate and gift tax exemption $600,000 exemption in 1987 would a compromise was never reached, so that it would continue to rise be a $1,285,000 exemption in 2016 and 2010 arrived without any from its $5 million level. The index - dollars. In other words, the current change in law, triggering the one- ing provision caused the exemption $5.45 million (indexed) exemption year repeal of the estate and GST to rise to $5.12 million in 2012. is quite high by historic standards. taxes! With the ten-year sunset of In the most recent change to the 15 The Economic Growth and Tax Relief Rec - the legislation in effect, the law was estate tax, at the end of 2012 Con - onciliation Act of 2001, P. L. 107-16, 107th set to revert to 2001 parameters on gress made the adoption of porta - Cong., 1st Sess. (2001). 16 The Tax Relief, Unemployment Insurance 1/1/2011. In the final days of 2010, bility and the increases in exemp - Reauthorization, and Job Creation Act of 2010, P. L. 111-312, 111th Cong., 2nd Sess. (2010). Congress enacted a law that made tion level permanent. 17 So until 17 The American Taxpayer Relief Act of 2012, P. optional whether 2010 decedents’ further changes are made, the estate, L. 112-240, 112th Cong., 2nd Sess. (2013).

estates took advantage of the one- gift, and GST exemptions are uni - 18 Joulfaian, “The Federal Estate Tax: History, Law, and Economics,” Office of Tax Analysis, year estate tax repeal. 16 fied at $5 million indexed from U.S. Department of the Treasury (2013), Table As a result, the estate of a 2010 2010. Unused estate tax exemption 2.1 Historical Features of the Estate Tax. 19 Both President Obama and Democratic pres - decedent could elect out of the is portable to a surviving spouse, idential nominee Hilary Clinton point to the estate tax and be subject to the but unused GST exemption is not. $3.5 million exemption amount from 2009 as an appropriate exemption amount. modified carryover basis rules, or, 20 Joulfaian, supra note 18. if the estate did not make such an Exemptions and rates 21 “SOI Tax Stats—Historical Table 17: Taxable Estate Tax Returns as a Percentage of Adult election, it would be subject to Throughout the 100-year history of Deaths, Selected Years,” available at the estate tax but allowed a $5 mil - the transfer taxes, there have been www.irs.gov/uac/soi-tax-stats-historical-data- tables (last visited on 7/5/2016). lion exemption from estate tax. numerous changes to rates and 22 Id . Thus, for any taxable estate of $5 exemption amounts. 18 The exemp - 23 IRS Statistics on Income, available at www.irs.gov/uac/soi-tax-stats-estate-tax-sta - million or less (which included over tion level generally has increased tistics-filing-year-table-1 (last visited on 99% of 2010 decedents), it gener - over time. The initial exemption 7/5/2016). 24 Internal Revenue Service Data Book, 2015 , ally would be advantageous to amount from 1916 was $50,000. “Table 1: Collections and Refunds, By Type remain “subject” to the estate tax Other than a brief increase to of Tax, Fiscal Years 2014 and 2015,” page 3, available at www.irs.gov/pub/irs-soi/ but eligible for a $5 million exemp - $100,000 in the period from 1926 15databk.pdf (last visited on 7/5/2016).

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While the exemption level has $60,000 estate tax exemption, are The receipts from estate and gift generally increased over the years, exposed to the graduated rate table. taxes make up only a small portion the top marginal estate and gift of overall federal tax revenues. For tax rate has generally fallen over the Who pays estate tax fiscal year 2015, the estate and While we do not have good data for past 35 years. 20 While the estate tax gift taxes supplied only 0.7% of fed - had a modest 10% rate at its incep - the first 20 years the estate tax was eral tax revenue, as compared to tion in 1916, the top marginal rate imposed, we know that from the 49.8% from the individual, trust, climbed rapidly during the world mid-1930s to the mid-1950s 1% to and estate income taxes, and 35.2% 2% of decedents owed estate taxes wars, and remained high until 1981. from employment taxes. 24 Never - A top rate of 70% was put in place at death. With the exemption level theless, because only the wealthiest in 1935, although it only applied to relatively stagnant, the percentage individuals pay estate and gift taxes, estates in excess of $50 million. Over of estates subject to estate tax crept these taxes still aid the overall pro - the next few years, the top rate up through the 1960s and 1970s gressivity of the federal tax system. climbed further to 77%, and the to peak at over 7% in 1976. A misunderstood tax estates to which the top rate applied Increased exemptions over the next 20 years kept that percentage to While the estate and gift taxes are declined to $10 million in 1941 and around 2% until the large increas - very progressive and clearly accom - to $5 million in 1977. es in exemption came into effect in plish some degree of wealth redis - The trend of increasing top mar - the early 2000s, and those subject tribution, polls indicate that the ginal rates turned the corner in 1982. to the estate tax fell to about 1% public does not perceive the taxes The top rate plateaued at 55% for of decedents. In recent years, the that way. In a 2002 survey con - the period from 1984 through 2001, 21 percentage of decedents subject to ducted by NPR, the Kaiser Foun - and then it began to decline again estate tax has fallen to about two dation, and the Harvard Kennedy under the 2001 tax act. The top rate tenths of a percent (0.2%). Unless School, 57% surveyed favored reached its low point in recent his - indexing is repealed, the percentage eliminating the federal estate tax, tory at 35% in 2010 through 2012, of estates subject to estate tax is like - while only 15% favored keeping but increased somewhat to 40% in ly to remain around 1% or less. the tax. (The remaining 28% said 2013. Because of the large exemp - they did not know enough to tion amount, the graduated rate Revenue express an opinion.) 25 However, table has no consequence to U.S. In absolute terms, the revenue from 49% surveyed thought that most estates and the tax is imposed at a the estate tax peaked in the period families had to pay the estate tax, flat 40%. Only certain non-U.S. between 1999 and 2006, at over when in fact in 2002 about 1% of estates, which still have only a $25 billion per year. 22 Recent changes decedents paid estate tax. 26 to rates and exemptions reduced the A series of Gallop polls in 2015 25 National Public Radio/Kaiser Family Foun - dation/Kennedy School of Govern- estate tax revenue to less than and 2016 illustrate a similar mis - ment.National Survey of Americans’ Views on understanding. In one poll, 63% of Taxes, available at www.npr.org/news/ $12 billion in fiscal year 2012, but specials/polls/taxes2003/20030415_taxes_ that revenue amount is depressed those surveyed in 2015 thought that survey.pdf (last visited on 7/5/2016). due to the one-year repeal of the money and wealth should be dis - 26 Id . 27 Newport, “Americans Continue to Say U.S. estate tax in calendar year 2010. Rev - tributed more evenly in the U.S. 27 Wealth Distribution is Unfair,” Gallop In another, 63% favored elimi - (5/4/2015), available at www.gallup.com/poll/ enue was back up to over $17 bil - 182987/americans-continue-say-wealth- lion in 2014, the most recent fiscal nating tax deductions and loop - distribution-unfair.aspx (last visited on 7/5/2016). year for which data is available. 23 holes for the rich when polled in

This article is reprinted from the September 2016 issue of ESTATE PLANNING , Copyright ©2016 Thomson Reuters/Tax & Accounting.

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SEPTEMBER 2016 VOL 43 / NO 9 WASHINGTON WATCH 42

2016. At the same time, 54% tax. Another explanation is that years, it would not be surprising to said they would favor eliminating Americans dream of becoming see further changes, even substan - the estate tax, while only 19% wealthy enough to be subject to tial changes, such as a shift to tax - opposed elimination of the estate the estate tax, and they do not ing bequests and gifts as income, or tax. want to be taxed on their wealth 28 taxing capital gains at death in lieu This misunderstanding could if they do. of taxing overall wealth. However, be responsible for some of the because of the growing inequality unpopularity of the modern estate The next hundred years Even with its low popularity rate, of wealth in the U.S. and the abili - ty to temper that growth through 28 Newport, “Americans React to Presidential there is reason to believe that a tax Candidates’ Tax Proposals,” Gallop taxation, some sort of tax at death (3/17/2016), available at www.gallup.com/ at death will persist in one form or poll/190067/americans-react-presidential- another. Given all of the changes we will likely continue to play a role candidates-tax-proposals.aspx (last visited on 7/5/2016). have seen in the estate tax’s first 100 in our tax system. ■

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