by Carol Warnick
Will the estate tax be eliminated as part of the tax reform promised by the incoming administration? Unfortunately, my crystal ball is not working well and I don’t have an answer for that question. I would, however, like to share a bit of the tortured history of the estate and gift tax since the Civil War in the hope that it might give us some perspective when wondering what the future will bring.
A series of Acts between 1862-64 created an inheritance tax which helped finance the war effort. Rates were between .75% and 5% and there was an exemption of $1,000. In 1870 the inheritance tax was repealed. An estate tax was again instituted to fund a war effort in 1916, in response to World War I. The rates were between 1% and 10% and there was an exemption of $50,000.
Since taxpayers figured out they could circumvent the estate tax if they simply transferred assets during life, Congress in 1924 initiated a gift tax. It was repealed in 1926 and then enacted again permanently in 1932. Various changes to the estate tax were made over the next several decades, including the addition of a marital deduction (although initially very different from what we have today.)
In 1976, the Tax Reform Act of 1976 (TRA) was enacted which revamped the entire estate and gift tax regimes by combining them into one unified system with a graduated rate of tax. It also introduced the generation skipping transfer tax.
The next significant changed occurred in 1981 with the Economic Recovery Tax Act (ERTA). It expanded the marital deduction and increased the unified credit, among other things. It also decreased the top tax rates from 70% to 50%. 1997 brought additional changes with the Taxpayer Relief Act. Changes included the addition of a family business deduction and inflation indexing for certain limits, like the annual gift tax exclusion.
In 2001 the Ecnomic Growth and Tax Relief Reconciliation Act (EGTRRA) made massive changes, with increasing exemption amounts reaching $3.5 million, culminating in a year with no estate tax at all in 2010. EGTRRA expired in 2011 and the estate tax was scheduled to return with a 55% tax rate and an exemption amount of $1 million. However, legislation passed with the 2010 Tax Act which established a maximum rate of 35% and an exemption of $5 million. Per the legislation, these changes were only good for 2 years and were set to expire on December 31,2012. Absent additional legislation, the old rules from 2001 would have applied again, reducing the exemption from $5 million to $1 million and increasing the tax rates from 35% to 55%.
In 2012, the American Taxpayer Relief Act (ATRA) came to the rescue by making “permanent” the exemption of $5 million (indexed for inflation) and a top tax rate of 40%. ATRA also made portability a permanent feature, allowing a spouse to utilize the deceased spouse’s unused exemption along with his or her own if certain requirements were met.
Now there is discussion among politicians and the new administration about repealing the estate tax completely, although there is also talk of going back to a carry-over basis regime for estates exceeding a certain amount, thus bringing in additional income tax revenue but only upon sale of the inherited asset.
The purpose of this blog is to point out that the only thing certain about the estate and gift tax is that there is constant change. If these taxes are repealed, then it may only be a matter of time before the political winds change and the estate and gift taxes come roaring back. The history of these taxes illustrates the possibility of such a pendulum swing. All these changes definitely keep estate planners on their toes, but make it difficult to advise clients.
In light of all this uncertainty on the tax front, we should remember that none of these tax issues really affect the family dynamics at the client’s death. The tax regime typically doesn’t change most client’s goals of creating a plan that really works for their beneficiaries and doesn’t create division in the family or spur lawsuits among beneficiaries or between beneficiaries and trustees. When all is said and done, crafting a plan that deals with these other “soft” issues, can be more rewarding and will benefit the client no matter which way the tax winds are blowing at the client’s death. And based upon history, the tax winds are constantly shifting.