[IMGCAP(1)][IMGCAP(2)]With the 2016 presidential election dominating this fall’s news cycle, you may have overlooked an important and significant celebration—the centennial birthday of the estate tax.
Yes, that’s right. On Sept. 8, 1916, the modern estate tax was born. On the 50th birthday of the estate tax, Star Trek premiered on television. In 1986, on the 70th birthday of the estate tax, the Oprah Winfrey Show had its first national broadcast. Former presidential hopeful Bernie Sanders and award-winning singer Pink both share their birthday with the estate tax. Who knew?
The modern estate tax was first enacted under Woodrow Wilson as part of the Revenue Act of 1916. The 1916 Act doubled the rate of income tax (the lowest bracket increased from 1 percent to 2 percent, and the highest increased from 7 percent to 15 percent), and added an inheritance and munitions profits tax.
This first iteration of the modern estate tax provided an exemption for U.S. residents for the first $50,000 of wealth transferred, with tax rates from 1 percent to 10 percent (10 percent applying to estates in excess of $5 million). In 2016 dollars, the exemption would shelter about $1.1 million, but the top rate would only apply to estates in excess of $110 million. In 2016, the estate tax is imposed at a rate of 40 percent to the transfer of wealth in excess of $5.45 million. In 1916 terms, this would have amounted to an exemption of about $247,000. However, without an accompanying gift tax that applied to lifetime transfers, the young, immature estate tax was easily thwarted.
Today, we operate with a much more complex set of rules, a unified estate and gift tax and a generation-skipping transfer tax. Like any centenarian worth her salt, the modern estate tax has changed its appearance and approach to life in its 100 years.
A sibling: Knowing that the estate tax could get lonely, in 1932, a gift tax was added that applied to lifetime transfers to combat the ability of wealthy individuals to avoid the estate tax by simply giving away all of their assets during their lifetimes. An earlier gift tax was enacted in 1924, but was then repealed in 1926. Also in 1932, the maximum estate tax rate increased to 45 percent. But, like many siblings, one was favored over the other and the gift tax rate was set at 75 percent of the prevailing estate tax rates. Like today, it remained “cheaper” to makes gifts during one’s lifetime than to pay the estate tax at death.
Growing pains: In 1942, the estate tax base was expanded to include a majority of powers of appointment and included most insurance on the decedent’s life, payable to the decedent’s estate or paid for by the decedent. The Internal Revenue Code of 1954 retooled the tax base of the estate tax to exclude insurance the decedent never owned.
All grown up: Under the Tax Reform Act of 1976, at the spry age of 60, the estate tax finally unified with its younger counterpart, the gift tax. Following the ’76 Act, one framework applied to tax lifetime gifts and transfers at death, with graduated rates. The ’76 Act combined the previously separate exclusions for estate and gift taxes and transformed them into a single, unified estate and gift tax credit to be used against either lifetime gifts or transfers at death. The ’76 Act also produced new offspring in the transfer tax world: the first iteration of the generation-skipping transfer tax. Under the 1976 version of the GSTT, the transferor was allowed to transfer up to $1 million to generation-skipping transfer trusts tax-free. Any amounts higher than the $1 million level would be taxed at the highest marginal estate tax rate. This version of the GSTT was retroactively repealed in 1986 by the Tax Reform Act of 1986. The current version of the GSTT was enacted to replace the ’76 version and applied to both direct skips and indirect skips at the top marginal estate tax rate. The ’76 Act also briefly flirted with a carry-over basis regime for inherited assets, something we would not see again until 2010.
Being married isn’t so bad after all: Beginning in 1981, The Economic Recovery Tax Act of 1981 provided for an unlimited marital deduction against estate and gift tax for transfers to a spouse. The ’81 Act also allowed the marital deduction for life interests benefitting a surviving spouse that were not terminable if the property was qualified terminable interest property. In 1988, Congress addressed its fears that surviving non-U.S. citizen spouses would avoid estate taxes by simply leaving the country and disallowed the marital deduction for non-U.S. citizen spouses and limited the marital deduction to assets held in a qualified domestic trust on benefit of the non-U.S. citizen spouse.
A near-death experience: The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) attempted to phase out and ultimately repeal—for one year in 2010—the estate tax and GSTT. Because of the applicable budgetary guidelines, the 2001 legislation would sunset after 10 years. Although it was widely believed that Congress would enact further legislation to address the 10-year sunset, the legislators did not reach a consensus and the estate tax and GSTT were repealed in 2010, marking the (temporary) death of the modern estate tax. With EGTRRA expiring on Dec. 31, 2010, it looked as though the impacted tax laws would revert to 2001 status.
Still kicking at 100: Congress was busy in the final days of 2010 and enacted only temporary legislation. It was made a permanent law later in 2012, bringing us to our current estate tax regime. Both the $5 million estate and GSTT exemptions held in place for 2011 and 2012, with the full amount allowable against lifetime gift, and with an inflation adjustment—providing the current exemption of $5.45 million in 2016. The 2011 legislation also brought us portability of the estate and gift tax credit: If the first spouse to die did not use all of his or her credit at death, the surviving spouse could use the balance against lifetime gifts or at death. Sadly (for practitioners, anyway), the generation-skipping transfer tax exemption has not yet learned the same trick.
Having made it to age 100, the estate tax may again be in for a nip and a tuck, or perhaps a complete facelift, depending on how the presidential election plays out. Both of the leading presidential candidates propose modifications to the current estate tax regime: candidate Donald Trump would eliminate the estate tax, while Secretary Hillary Clinton has figured out the secret to reverse aging and would take seven years off the life of the estate tax by returning to 2009 parameters, in part. In addition, she’ll honor former presidential hopeful Bernie Sanders’ plans for the estate tax by adding three new higher brackets and repealing the step-up in basis. A 50 percent rate would apply to estates over $10 million a person, a 55 percent rate for estates of $50 million a person, and the top rate of 65 percent for estates exceeding $500 million a person.
While we cannot predict the outcome of the election, or if it will have any impact on the estate tax at all, the modern estate tax has so far refused to be put out to pasture. In doing so, it has kindly supplied employment for thousands of attorneys, accountants, wealth managers, insurance agents, family offices and the like. In California alone, at least 6,754 members proudly support the trusts and estates section of the California Bar. With all of this fuss, the White House Office of Management and Budget estimates $21.1 billion in receipts from estate and gift taxes in 2016 —less than 1 percent of revenue for the federal budget.
Three cheers to the estate tax. Happy 100!
Laura M. Chooljian is an associate in Los Angeles-based Greenberg Glusker Fields Claman & Machtinger LLP’s Private Client Services Group. She counsels high net worth individuals and families on issues involving estate and tax planning, business succession, wealth transfer, and post-death trust administration. Chooljian also counsels nonprofit organizations, including family foundations, operating foundations and public charities. Stefanie J. Lipson is a partner at Greenberg Glusker Fields Claman & Machtinger LLP. Her practice focuses on pro¬viding families with counsel in all aspects of their personal legacy planning, including operation and succession planning for family owned businesses, tax-efficient long-term wealth transfer solutions, and funding and ongoing administration of family foundations. Lipson specializes in providing tax counsel for multi-generational family owned busi¬nesses, real estate and tech entrepreneurs and high-profile entertainment industry figures.
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