MARQUETTE UNIVERSITY LAW SCHOOL
LAW ALUMNI CLE - PHOENIX, ARIZONA
Friday, March 11, 2011

The 111^th Congress and the Federal Estate Tax:
Taxes, Taxes, Taxes, What has the Congress Done With the Federal Estate and Gift Tax?

By: Louis J. Andrew, Jr., L '66

I. Recent History of the Federal Estate Tax (2001-2012)

A. Chart - See Table 1.

B. The Federal Estate and Gift Tax were modified as part of the Bush tax cuts in 2001. Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

1. The federal estate tax exemption amount increases from 2003 to 2009.

2. The lifetime gift tax exemption amount remains at $1 million during that period.

3. The death tax transfer exemption increases from 2001 to 2009 from $675,000 to $3.5 million.

4. The federal estate tax rate decreases from 2001 to 2009 from 55% to 45%.

5. The federal estate tax is eliminated in the year 2010, but the gift tax remains in effect for gifts in that year with a $1 million exemption and a 35% maximum tax rate.

6. In 2010 the stepped-up basis rules are repealed and they are replaced in 2010 by carryover basis rules.

7. In 2011 the death tax transfer exemption becomes $1 million and the highest estate and gift tax rates are 55%. The basis step-up rules return after the EGTRAA sunset. The tax becomes basically what it was prior to EGTRAA.

8. The state death tax credit allowed under the federal estate tax was modified throughout the period from 2001 to 2009, and the state death tax credit would return in 2011

9. The Wisconsin Estate Tax would also return as it is the amount of the federal state tax credit. Because the state death tax credit is reinstated so is the Wisconsin Estate Tax.

C. All of this was thrown out the window when the Federal Estate and Gift Tax were again modified (it sure took them a long time) in late 2010, after the Congressional Elections of 2010 by passing the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (Pub. L. 111-312), which provided:

1. The federal estate tax exemption amount increased to $5 million but only for 2011 and 2012.

2. The lifetime gift tax was unified with the estate tax and was raised to $5 million.

3. The unified estate and gift tax exemption is indexed to the cost of living after 2011.

4. The exemption of a deceased spouse is portable, meaning if the first spouse to die does not use all of their exemption, the surviving spouse may use their own exemption plus the amount unused from the deceased spouse.

5. The rate of tax for both gift and estate tax was reduced to 35%.

6. For those that died in 2010 and found that they liked the consequences of carry over basis with no estate tax, they could opt out of the new rules of 2011 and 2012 (with a stepped up basis but payment of a 35% estate tax) and have no estate tax but be subject to the stepped up basis rule. Real large estates would benefit some of the time with no estate tax but tougher basis rules because the capital gains rate is only 15% and the estate and gift tax rate is 35%. See IRS Form 8939 for making this election..

7. None of the tightening provisions that were threatened by various member of Congress were enacted. That included no new limitations on GRATS, curbs on valuation discounts, etc.

8. Once again, the rules are temporary. They expire on December 31, 2012. If nothing happens, on January 1, 2013, there will be an estate tax. The exemption will be $1 million. The tax rate will be 55%. There will be no portability. And, there will be a stepped up basis rule. This all presents problems for the estate planner.

1. We have no idea what Congress will do on January 1, 2012.

2. Clients are so befuddled by this that they are inclined not to see their estate planning lawyers. While they realize some day they will die but probably not before January 1, 2013, and maybe the Congress will act before that time and make these changes permanent.

3. Maybe increase the limits on your malpractice insurance.

9. For interesting reading on the history of the estate and gift tax I would recommend an article and a book. The article is "The Politics and Policy of the Estate Tax-Past, Present and Future" by Michael J. Graetz http://ssrn.com/abstract=1755161. This is a very lively article telling many political stories about the adoption of the present act. In addition, the name of the book is "Death by a Thousand Cuts" by Michael J. Graetz (also the author of the paper) and Ian Shapiro. One of the reviews calls it "a lively legislative chronicle."

II. What is effect on Wisconsin and other States' Death Taxes.

A. There is no effect in Wisconsin and at least until January 1, 2013 there is no Wisconsin Estate Tax that is in effect right now. Wisconsin is coupled to the federal state death tax credit. The credit was eliminated by EGTRRA in 2005 and changed to a deduction. Wisconsin is coupled to a credit that does not exist for 2011 and 2012.

B. Wisconsin may have an Estate Tax in 2013 if the Congress does not extend the current law and the Federal Estate Tax reverts to the same tax as we had in 2001 (pre EGTRRA). Wisconsin's Estate Tax would pick up the federal state death tax credit. This would translate into a $1 million exemption in Wisconsin.

C. Other states are a mixed bag. According to the American Family Business Foundation, combined state and federal gift taxes range from 35% for the federal rate to 54.1% in New Jersey, with New Jersey being the highest; then Maryland at 50.9%; Indiana at 48%, Washington at 47.4% and Nebraska at 46.7%. Twenty-two states have a state Estate Tax in addition to the Federal Estate Tax.

III. History of the US Wealth Transfer Tax System Before 2001

A. The first federal tax on death transfers were imposed from 1797 to 1802 as a stamp tax on inventories of deceased persons, receipts of legacies, etc. Between 1802 and the start of the Civil War there was no federal death transfer tax.

B. The federal government imposed an inheritance tax between 1862 and1870. This was used to finance the Civil War. An inheritance tax is different from an estate tax as it is levied on the amount received by any beneficiary where the estate tax is levied against the estate and on the amount of the entire estate.

C. In order to finance the Spanish-American War, the federal government imposed the first estate tax in 1898, which remained in effect until its repeal in 1902.

D. In 1906, President Theodore Roosevelt proposed a progressive tax on all lifetime gifts and death-time bequests, specifically for the purpose of limiting the amount that one individual could transfer to another individual. No legislation immediately resulted from this proposal.

E. The federal government in 1916 adopted a progressive estate tax on all property owned by the decedent, including certain lifetime transfers and all transfers made in contemplation of death. This tax provided an exemption in the form of a deduction of $50,000, with rates from 1% on the first $50,000 transferred, to 10% on transferred assets in excess of $5 million. The next year the revenue needs from the First World War resulted in an increase in the estate tax rate, with a top rate of 25% on transferred assets exceeding $10 million.

F. Estate taxes were reduced by the Revenue Act of 1918, but the tax was retained. Estate tax rates on transfers under $1 million were reduced. At the same time, the tax was extended to life insurance proceeds in excess of $40,000 that were receivable by the estate or the executor, and to property subject to a general power of appointment.

G. In 1924 the estate tax was changed by increasing the maximum rate to 40%, by broadening the property subject to the tax and by allowing state death tax credit.

H. In 1926 the gift tax was repealed and estate taxes were reduced to a maximum rate of 20% on transfers over $10 million. The exemption was increased from $50,000 to $100,000.

I. During the Depression, federal revenues were declining and, as a result, in 1932 estate tax rates were increased with a top rate of 45% on transfers over $10 million. The exemption was reduced to $50,000 and the federal gift tax was imposed at 75% of the estate tax rates for cumulative gifts in excess of $5,000 per year.

J. Estate and gift tax rates were further increased in 1934, with top rates of 60% and 45%, respectively, on transfers in excess of $10 million.

K. Again, in 1935 the tax rates were increased with top rates of 70% and 52%, respectively, on transfers in excess of $10 million. The exemption for both estate and gift tax was reduced in 1935 to $40,000 each.

L. In 1940 a 10% surcharge was imposed on both income and estate and gift tax rates to finance the Second World War.

M. Estate and gift tax rates were increased in 1941, with a top estate tax rate of 77% on transfers in excess of $50 million.

N. In 1942 Congress again altered the estate and gift taxes by setting the exemption at $60,000, setting the lifetime exemption for gifts at $30,000 and providing an annual exclusion of $3,000.

O. The above rates stayed in effect for quite a period of time, but in 1958 the Small Business Tax Revision Act of 1958 provided for payment of federal income taxes on certain closely held business interests in installments over a 10-year period.

P. The federal estate and gift taxes were changed dramatically by the Tax Reform Act of 1976.

1. The Act unified the estate and gift tax with a single graduated rate schedule with a maximum of 70% applied to transfers during life and death.

2. Estate and gift tax exclusions were combined in a single "unified credit" which, at the time, effectively exempted $175,625.

3. The 1976 Act also changed the rules applicable to disposition of inherited assets from a rule that only taxed post-death appreciation to one that provided that heirs' basis generally would be the same as it was in the hands of the decedent. In other words, the decedent's basis would "carry over" to be the basis to the heir.

4. In addition, the Act provided a 100% marital deduction for the first $250,000 on property transferred to a surviving spouse.

5. A transfer tax on generation-skipping transfers was also imposed for the first time.

6. The 1976 Act also included preferential rules for valuing family farms and small businesses.

Q. In 1980 the estate tax carry-over basis rules were retroactively repealed and replaced with the stepped-up basis rules.

R. The Economic Recovery Tax Act of 1981 made a number of big changes to the federal estate and gift tax.

1. The Act increased the unified credit so that when it was fully phased in in 1987 it exempted the first $600,000 of transfers.

2. It also reduced the top unified estate and gift tax rate from 70% to 50% over a 4-year period.

3. Furthermore, the 1981 Act provided an unlimited deduction for transfers to spouses.

S. In 1984, 1986 and 1987 various technical changes were made to the federal estate tax rules.

1. The 1986 Act changed the generation-skipping tax rules.

2. The 1987 Act modified estate freeze transactions.

3. The 1981 Act also increased the annual gift tax exemption from $3,000 to $10,000.

4. There were other technical changes made to each of these Acts.

T. The Omnibus Budget Reconciliation Act of 1993 restored the 55% top rate retroactively to January 1, 1993, and made that top rate permanent.

U. The Taxpayer Relief Act of 1997 provided for gradual increases in the unified credit effective exemption amount from $625,000 in 1998 to $1 million in 2006 and thereafter.

V. This brief history brings the federal estate tax rate up to the point when EGTRRA was passed.

W. See Tables 1 and 2 for the estate and gift tax rates and exemption amounts from 1977 to 2010.

X. For more information on the history of the Federal Wealth Transfer System see "History, Present Law, and Analysis of the Federal Wealth Transfer Tax System" published by the Joint Committee on Taxation JCX-108-07.

IV. Various considerations in adopting a more permanent estate tax

A. Revenue received by the federal government from the estate, gift and generation-skipping transfer taxes is shown Table 3.

B. A comparison of transfer taxation in the United States to other countries is shown on Table 4.

1. The inheritance tax is more common in other countries rather than the estate tax imposed in the United States.

2. The U. S. imposes a generation-skipping tax, which effectively raises the marginal tax rates. Most other countries do not do this.

3. The table reveals that there are quite a number of countries that collect more by their wealth transfer taxes as a percent of GDP than the United States, but there are 16 countries that collect less than half as much revenue as a percentage of GDP from such taxes as did the United States.

4. Some countries have carry-over basis rules that would skew the results of the present table.

C. There seems to be no consensus among economists as to the effect of wealth taxes on savings and investment and how interrelated the income tax may be to the taxpayer's behavior along with wealth taxes.

D. Some observers note that the transfer tax system may impose special cash flow burdens on small or family-owned businesses. These observers note that if a taxpayer holds a substantial proportion of its wealth invested in one enterprise, the need to pay estate taxes may force heirs to liquidate all or part of the enterprise and to encumber the business with debt to meet the estate tax liability. To the extent that small business is the largest creator of new jobs in America, this can be an increasingly important subject. Others state that the excuses for reducing the estate tax because of small business are way overstated. Table 5 shows the incidence of use of the Special Use Valuation or Electing Deferral of Tax Liability for the year 2003.

E. Some analysts have suggested that the charitable estate tax deduction creates a strong incentive to make charitable bequests and that changes in the federal estate tax could alter the amount of funds that flow for charitable purposes. On the other hand, some economists say that the wealthier a person is, the more likely that person is to make charitable bequests.

F. Table 7 shows that a substantial dollar value of charitable bequests are claimed annually. In 2005 the value of all charitable bequests claimed on estate tax returns exceeded $20.4 billion and represented 11.1% of the aggregate value of gross estates reported on those returns.

G. Some critics of federal transfer taxes find that the amount of money incurred in attempting to avoid taxes is socially wasteful. They say that such costs represent an efficiency loss to the economy, in addition to whatever distorting effects federal transfer taxes may have on other economic choices. All attorneys that do any amount of estate planning understand how this may be the case. There is disagreement among analysts regarding the magnitude of these cost avoidance activities.

H. And there are many who feel we should not have an estate tax at all for many reasons that are not part of this talk. See the book referred to above called "Death By A Thousand Cuts" for exhaustive explanations on both sides of the issue of whether we should have an estate tax.

© 2011 by Andrew Law Offices, S.C.

Circular 230: Unless otherwise expressly indicated, if this email (or any attachment hereto) contains advice concerning any federal tax issue or submission, please be advised that the advice was not intended or written to be used, and that it cannot be used, for the purpose of avoiding federal tax penalties.

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