Last month’s Captain’s Table piece, was the first installment in a three-part series on estate planning. Estate planning is the “most overlooked, misunderstood and procrastinated piece” of the financial plan for most families, when it really shouldn’t be. Putting together a good estate plan is relatively straight-forward, especially with the help of an experienced attorney, and is not as costly, complex or time-consuming as you might think.

In Part one, we discussed the will and the trust. We discussed why the will is the foundation of any estate plan and how a trust can be a flexible, efficient and an inexpensive tool that complements the will, and can also helps keep matters private and outside of the public record. In this installment, we’ll focus on the history of the estate and gift tax system and how present laws impact bequests made while living and at death.

Estate taxes have been with us since antiquity. Taxation of property transfers at death can be traced back to ancient Egypt, as early as 700 B.C.(1) Not to be outdone by Egypt, Roman Emperor Caesar Augustus imposed the “Vicesina Hereditatium,” a tax on successions and legacies to all but close relatives.(2) Centuries later taxes imposed at the death of a family member found their way to medieval Europe, often amounting to a family’s annual property rent to the landowner. Governments always seem to come up with new, ingenious ways to raise revenue, and by the 18th century, stamp duties and registration fees on wills, inventories, and other documents related to property transfers at death had been adopted by many nations, including that of the newly formed United States of America.

In early U.S. history, taxes related to the transfer of property were enacted almost exclusively during times of war to raise revenue for the war effort, and they were customarily repealed shortly after the war had finished. Congress passed the Stamp Tax of 1797 to raise money for a Navy to defend the U.S. against a threat from France. Federal stamps were required on wills and all sorts of probate-related documents.(3) In 1802, the tax was repealed when fears of war faded.(4) During the Civil War, the Federal Government passed the Revenue Act of 1862 to raise money for the Union cause. The Act included the nation’s first true legacy or inheritance tax, but bequests to surviving spouses, bequests of real estate, and small estates were exempted. In 1864, the mounting cost of the war led to a reenactment of the Revenue Act. More expansive provisions were added and included a “succession tax” – the nation’s first inheritance tax on real estate, and a tax on real estate bequests made during the decedent’s life - the nation’s first gift tax. Bequests to widows--but interestingly not widowers-- were exempted, as well as smaller bequests to minor children. The legacy and succession taxes were repealed in 1870, and the stamp tax was repealed in 1872.(5, 6) The Spanish-American War brought about the fiercely contested Federal legacy tax, which became law in 1898.(7) Although called a legacy tax, it was a duty on the estate itself, not on its beneficiaries, and it served as a precursor to the present Federal estate tax. The tax only applied to personal property and exemptions were again provided for surviving spouses and small estates. A few years later, in 1901, certain gifts were exempted from the tax, including charitable gifts.(8) The war ended in 1902 and the tax was repealed later that same year.(9)

In the years immediately following the repeal of the Federal legacy tax, an unprecedented number of mergers in the manufacturing sector of the U.S. economy created a concentration of wealth in a relatively small number of powerful companies and the hands of the businessmen who headed them. This concentration of wealth and power caused fear and sparked the growth of the progressive movement. Progressives advocated both an inheritance tax and a graduated income tax as tools to address inequalities in wealth. This thinking eventually led to the passage of the 16th Amendment to the Constitution and the enactment of the Federal income tax. It was not until the advent of another war, World War I, that Congress would enact the Federal estate tax. The Revenue Act of 1916 created a tax on the transfer of wealth from an estate to its beneficiaries, and thus was levied on the estate, as opposed to an inheritance tax that is levied directly on beneficiaries.

A century has passed since the inception of the Federal estate tax, and Congress has periodically altered the law, including changes to filing thresholds, tax brackets, and marginal tax rates. In 1976, tax code changes created a unified estate and gift tax framework and merged the estate tax exclusion and the lifetime gift tax exclusion into a single, unified estate and gift tax credit. The Economic Recovery Tax Act of 1981 introduced unlimited estate and gift tax marital deductions, thereby eliminating quantitative limits on the amount of estate and gift tax deductions available for spousal transfers. Sixteen years later, Congress indexed a number of thresholds and limits for inflation, among other things.

More recently, The Economic Growth and Tax Relief Reconciliation Act of 2001 called for the phase-out of the federal estate tax. Most tax experts expected Congress to change the law before that happened, however the estate tax effectively vanished in 2010, but for that single year only. Not surprisingly, the estate tax was reinstated in 2011, and estate and gift tax thresholds were again indexed for inflation. The American Taxpayer Relief Act of 2012 (ATRA) made the estate tax a permanent part of the tax code and made the exclusion amount automatically indexed for inflation. For 2015, the exclusion amount is $5.43 million per person. The ATRA also bumped the tax rate on estates in excess of the exemption amount from 35% to 40%. The Act also changed gift tax rules somewhat.

The annual gift tax exclusion is the amount of money or items of value you’re permitted to gift to as many individuals as you want without triggering the gift tax. For 2015, the gift tax exclusion amount is $14,000, and it will increase regularly for inflation. In addition to the annual exclusion amounts, you can also gift to charities, your spouse, political organizations, and to others for educational or medical expenses, without triggering the gift tax. Exceptions apply, however. Finally, the ATRA also provided for permanent “portability” between spouses. This allows the surviving spouse to take advantage of any unused estate and gift tax exemption left by the first spouse.

The scope of the estate tax and gift tax system, also known as the “transfer tax” system, is quite narrow when you measure the size of the population directly affected by the system. In fact, only about 2% of all adult deaths require the filing of an estate tax return. So it’s not surprising to most that, in recent years, Federal estate and gift taxes have made up about 1% of the total federal budget, and have averaged between 1% and 2% of the budget since World War II.

However, it’s important to know the basic issues related to estate and gift taxes because tax rates for both are very high, meaning a miscalculation could be costly. The top estate and gift tax rates are 40%, so it makes financial sense to do all you can to avoid having to pay unnecessary estate and gift taxes that could have possibly been avoided with a little planning.

 1 Paul, Randolph E. (1954), Taxation in the United States, Little, Brown, and Company, Boston, MA.

2 Smith, Adam (1913), An Inquiry into the Nature and Causes of the Wealth of Nations, E.P. Dutton, New York.

3 Stamp Act of 1797, 1 Stat. 527.

4 Zaritsky, H. and T. Ripy (1984), Federal Estate, Gift, and Generation Skipping Taxes: A Legislative History and Description of Current Law, Report No. 84-156A.

5 Internal Taxes, Customs Duties Act of 1870 §27, 16 Stat. 269.

6 Internal Revenue Act of 1867, 14 Stat. 169, Customs Duties and Internal Revenue Taxes Act of 1872 §36, 17 Stat 256.

7 War Revenue Act of 1898, 30 Stat. 448, 464.

8 War Revenue Reduction Act of 1901, 31 Stat. 956.

9 War Revenue Repeal Act of 1902, §7, 32 Stat. 92.