Federal Estate Tax

Devan Redington

Federal Estate Tax

Introduction

        Federal estate taxes have been a heavily debated topic since the law was introduced in 1916. The IRS defines estate taxes as “a tax on your right to transfer property at your death.”^[1]

A History of the Tax

        Estate taxes trace back to as early as 700 B.C. Historians believe there was a 10% tax in Egypt on the transfer of property upon death. In the United States, the tradition of taxing assets after death was used on and off from 1797 to fund wars. The first federal estate tax law was passed under the Stamp Act of 1797 to fund an undeclared naval war on France. It was repealed 5 years later, and another law was not passed requiring the tax until the Tax Act of 1862. This particular act was enacted to help finance the Civil War and was repealed in 1870.^[2] 

        Two important Supreme Court cases set the stage for the estate taxes Americans face today. First, in 1874 a citizen argued estate taxes are unconstitutional because they are a direct tax and under the Constitution, must be allocated among the states according to population. The Supreme Court disagreed arguing direct taxes tax land, houses and other permanent real estate. 2 

        The second case didn’t directly involve the issue of estate taxes, but instead challenged the legality of the Income Tax Act of 1894. However, this lawsuit indirectly affected estate tax laws because it included gifts and inheritances subject to income tax. “The Supreme Court struck down the whole bill because the tax was imposed on, among other things, real estate gains and, therefore, was considered a direct tax.” This ruling set the stage for the Sixteenth Amendment and allowed the government great freedom on the kinds of taxes it can collect.2

The Modern Day Estate Tax

        The estate tax as Americans know it today was enacted under the Revenue Act of 1916. Congress used the estate tax as a way to redistribute income and prevent the majority of the wealth from being controlled by a few families. Interestingly, the exemption amounts were quite different than today’s amounts. A 1% tax started at $50,000 (over $11 million in 2004) and climbed to 10% on estates over $5 million ($1 billion in 2004). At one point, during the 1940s through the 1960s, tax rates on the largest estates were close to 80%. ENTER TODAYS AMOUNTS. Instead of repealing the tax after World War I, congress enacted the gift tax in 1924, despite budget surpluses.^[3]  

        In 2001, congress began phasing out the estate tax under the Economic Growth and Tax Relief Reconciliation Act of 2001. The tax was scheduled to be eliminated in 2010, but congress couldn’t decide what to do and in 2011 estates over $5 million began being taxed at 40%. NEED CITE

An Argument For Estate Taxes

        According to the Urban-Brookings Tax Policy Center, only 1.4 out of every 1000 estates will pay estate tax; thus, only the wealthiest 0.14 percent of Americans are effected by the tax. The Tax Policy Center also estimates that the effective tax rate (the percentage of the estate’s value that is actually paid) is only 16.6 percent, which is significantly lower than the top estate tax rate of 40 percent. This is because only the value of the estate above $5.3 million is actually taxed. Furthermore, TPC estimates that the estate tax will generate about $200 billion over the next 10 years. TPC states “this is roughly the same amount that the government will spend over this period on the Food and Drug Administration, the Centers for Disease Control and Prevention, and the Environmental Protection Agency combined.”^[4]

        Opponents of the estate tax, continually point to the issue of passing on small family owned businesses. While it is estimated that only 20 small businesses and family farms faced any estate tax in 2013, the amount they paid was, on average, only 4.9 percent of their total value. There is also a provision in the law allowing farms and businesses to spread out estate tax payments over 15 years at very low interest rates. 4This provision helps with the liquidity issue and allows estate tax payments to be made without causing families to have to sell any assets of the farm or business.  

        Finally, opponents also argue the estate tax is double taxation because it taxes assets that were already taxed when they were earned. This theory has been proven untrue because the large majority of assets taxed by the estate tax are assets that qualify as capital gains. These assets are not taxed until they are sold. These assets are never subject to income tax if the owner hold them until death. According the Federal Reserve estimates, as much as 55 percent of the value of estates worth more than $100 million are made up of these assets. Furthermore, if these assets were taxed as capital gains instead, they would be taxed at 20 percent instead of the effective tax rate for estates of 16.6 percent.4