Federal Taxation of Inheritance and Wealth Transfers
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Federal Taxation of Inheritance and Wealth Transfers
Barry W. Johnson and Martha Britton Eller, Internal Revenue Service
n Introduction: Inheritance and Taxation
Inheritance in Early America: English Foundations
For most of the 20th century and at key points
throughout American history, the Federal government
has relied on estate and inheritance taxes as sources of
funding. The modern transfer tax system, introduced in
1916, provides revenue to the Federal government
through taxes on transfers of property between living
individuals--inter vivos transfers--as well as through a
tax on transfers of property at death. Proponents of
transfer taxation embrace it both as a “fair” source of
revenue and as an effective tool for preventing the concentration of wealth in the hands of a few powerful families. Opponents claim that transfer taxation creates a
disincentive to accumulate capital and, thus, is detrimental to the growth of national productivity. Controversy
over the role of inheritance in democratic society and
the propriety of taxing property at death is not new, but
is rooted firmly in arguments that have raged since
Western society emerged from its feudal foundations.
Central to both historic and current debate is the divergent characterization of inheritance as either a “right”
or a “privilege.” An understanding of these arguments,
and of the history surrounding the development of the
modern American transfer tax system, provides a foundation for evaluating current debates and proposals for
changes to that system.
American ideas concerning the rights of individuals in the new republic can be traced to the writings of
English philosopher John Locke. Writing in the last half
of the 17th century, he suggested that each citizen was
born with certain natural, or God-given, rights; chief
among those rights was property ownership. Citizens
had a right to own as much property as they could employ their labor upon, but not to own excessive amounts
at the expense of the rest of society. Further, he argued
that the right to bequeath accumulated property to children was divinely ensured. “Nature appoints the descent of their [parent’s] property to their children who
then come to have a title and natural right of inheritance
to their father’s goods, which the rest of mankind cannot pretend to” (Locke, 1988:207). Likewise, Locke
felt that a father should inherit a child’s property if the
child died without issue. If, however, a person died
without any kindred, the property should be returned to
society. Government was established at the will of the
people and was charged with protecting these rights, according to Locke. However, government had an even
higher responsibility--to ensure the benefit of all society. When societal and individual rights clashed, suggested Locke, it was the civil government’s duty to exercise its prerogative in order to ensure the common
good.
n Historical Overview
The idea that inheritance was a “natural right” was
refuted nearly a century later by English jurist William
Blackstone. In his 1769 Commentaries on the Law of
England, Blackstone wrote that possession of property
ended with the death of its owner and, thus, there was
no natural right to bequeath property to successive generations. Therefore, any right to control the disposition
of property after death was granted by civil law--not by
natural law--primarily to prevent undue economic disturbances. Thus, Blackstone concluded that the government had the right to regulate transfers of property
from the dead to the living. His interpretation of law
Taxation of property transfers at death can be traced
back to ancient Egypt as early as 700 B.C. (Paul, 1954).
Nearly 2,000 years ago, Roman Emperor Caesar
Augustus imposed the Vicesina Hereditatium, a tax on
successions and legacies to all but close relatives (Smith,
1913). Taxes imposed at the death of a family member
were quite common in feudal Europe, often amounting
to a family’s annual property rent. 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.
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“has served as the legal foundations upon which death
taxes in Anglo-American tax systems rest” (Fiekowsky,
1959:22).
regulation. As in other areas of American life, Jefferson
heavily influenced later thinking about property rights,
inheritance, and taxation by governmental bodies.
The belief that government was responsible for the
protection of the general good, espoused by John Locke
and others, laid the foundation for the Utilitarian movement in English social philosophy. Jeremy Bentham,
one of the greatest proponents of Utilitarian philosophy,
rejected the idea of natural rights. Instead, he stressed
the higher goal of ensuring the general welfare. He and
his followers believed in a government that played an
active role in moving society toward that goal. Bentham,
therefore, advocated strong regulation of inheritances
“in order to prevent too great an accumulation of wealth
in the hands of an individual” (Chester, 1982:18).
The Stamp Tax of 1797
In general, early American government adopted a
laissez-faire approach to the economy, an approach advocated by Adam Smith. However, when Congress
needed to raise additional funds in response to the undeclared naval war with France in 1794, it chose a death
tax as the source of revenue. The Stamp Act of 1797
was enacted to finance the naval buildup necessary for
the national defense. Federal stamps were required on
wills offered for probate, as well as on inventories and
letters of administration. Stamps were also required on
receipts and discharges from legacies and intestate distributions of property (Zaritsky and Ripy, 1984). Duties were levied as follows: 10 cents on inventories and
the effects of deceased persons, and 50 cents on the probate of wills and letters of administration. The stamp
tax on the receipt of legacies was levied on bequests
larger than $50, from which widows (but not widowers), children, and grandchildren were exempt. Bequests
between $50 and $100 were taxed 25 cents; those between $100 and $500 were taxed 50 cents; and, an additional $1 was added for each subsequent $500 bequest.
In 1802, the crisis ended, and the tax was repealed (Repeal of Internal Tax Act, 1802). In 1815, Treasury Secretary Alexander Dallas proposed the resurrection of the
tax to provide revenue for the war with England. The
Treaty of Ghent, however, ended the war while the tax
was still under consideration, and the tax was subsequently dropped (Zaritsky and Ripy, 1984).
Yet, the idea of government actively engaged in promoting the general welfare was rejected by economist
Adam Smith, a contemporary of both Blackstone and
Bentham and the father of classical economics. Smith
believed that an unregulated economy, driven by the
natural interplay of selfish individual desires, would produce the greatest good for society. While he seemed to
accept the government’s right to tax inheritances, he argued against it. He called all taxes on property at death
“more or less unthrifty taxes, that increase the revenue
of the sovereign, which seldom maintains any but unproductive labor, at the expense of the capital of the
people, which maintains none but productive” (Smith,
1913:684). Later, economist David Ricardo, writing in
the early 19th century, reinforced the idea. He suggested
that English probate taxes, legacy duties, and transfer
taxes “prevent the national capital from being distributed in the way most beneficial to the community”
(Ricardo, 1819:192).
In the years immediately preceding the war between
the States, revenue from tariffs and the sale of public
lands provided the bulk of the Federal budget. Inheritance taxes, however, were a source of revenue for many
States. Early in the 19th century, Supreme Court Justices John Marshall and Joseph Story defended an
individual’s natural right to own property. However,
their belief that inheritance was a civil, not a natural
right affirmed the States’ right to regulate inheritances
(Chester, 1982). Later, U.S. Supreme Court Justice
Roger Taney, a Jackson appointee, described the inheritance tax in the case of Mager v. Grima (1850). “If a
These, then, are the somewhat divergent philosophies from which Thomas Jefferson, in drafting the Declaration of Independence, developed his idea of Godgiven, or natural, rights that emphasize personal and political freedoms. Jefferson argued that the use of property was a natural right, but that the right was limited by
the needs of the rest of society. Furthermore, he also
argued that property ownership ended at death. While
he did not call for abolishing the institution of inheritance, he did advocate a strong role for government in its
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FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
State may deny the privilege [of inheritance] altogether,”
he wrote, it may, when it grants that privilege, “annex to
the grant any conditions, which it supposes to be required by its interests or policy” (49 U.S.:494).
Far from a source of controversy, the inheritance
tax was praised in the Congressional Globe as a “large
source of revenue, which could be most conveniently
collected” (Office of Tax Analysis, 1963:2). Senator
James McDougall of California argued that the tax was
the least burdensome alternative for raising needed revenue because “those who pay it, never having had it,
never feel the loss of it” (Paul, 1954:15). According to
The Internal Revenue Record, the 1862 tax was “one of
the best, fairest, and most easily borne [taxes] that political economists have yet discovered as applicable to
modern society” (1869:113).
The Tax Act of 1862
The advent of the Civil War again forced the Federal government to seek additional sources of revenue,
and a Federal inheritance tax was enacted in the Tax
Act of 1862. However, the 1862 tax differed from its
predecessor, the stamp tax of 1797. In addition to a
document tax on the probate of wills and letters of administration, the 1862 tax package included a tax on the
privilege of inheritance. Originally, the tax only applied
to the devise of personal property, and tax rates were
graduated based on the legatee’s relationship to the decedent, not on the value of the bequest or size of the
estate. Rates ranged from 0.75 percent of bequests to
ancestors, lineal descendants, and siblings to 5 percent on
bequests to distant relatives and those not related to the
decedent. Estates of less than $1,000 were exempted, as
were bequests to the surviving spouse. Bequests to charities were taxed at the top rate, despite pleas from many in
Congress that the tax should be used to encourage such
gifts (Office of Tax Analysis, 1963). In addition, the stamp
tax ranged from 50 cents to $20 on estates valued up to
$150,000, with an additional $10 assessed on each $50,000
or fraction thereof over $150,000.
The mounting cost of the Civil War led to the reenactment of the 1862 Revenue Act, with some modifications. These changes, established in the Internal Revenue Law of 1864, included the addition of a succession
tax--a tax on bequests of real property--and an increase
in legacy tax rates (see Table 1). In addition, the tax
was applied to any transfers of real property made during the decedent’s life for less than adequate consideration, thus establishing the nation’s first gift tax. Wedding gifts were exempted. Transfers of real property to
charities, again, were taxed at the highest rates. Bequests to widows, but not widowers, were exempt from
the succession tax, as were bequests of less than $1,000
to minor children.
The end of the Civil War and subsequent discharge
T a b le 1: 1864 D e a th Tax Rates
Relationship
Rates on
Rates on
Increase in legacies
real property
legacies
over 1862
Lineal issue, ancestors
1.00%
1.00%
0.25%
S iblings
2.00%
1.00%
0.25%
D e s c e n d a n t s o f siblings
2.00%
2.00%
0.50%
Uncle, aunt, and their descendants
4.00%
4.00%
1.00%
Great uncle, aunt, and their descendants
5.00%
5.00%
1.00%
Other relatives, not related
6.00%
6.00%
1.00%
Charities
6.00%
6.00%
1.00%
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of the debts associated with the war gradually eliminated
the need for extra revenue provided by the 1864 Act.
Therefore, in 1870, the inheritance tax was repealed (Internal Tax Customs Duties Act). The probate tax was
modified in 1867 to exempt all estates less than $1,000
(Internal Revenue Act of 1867), and repealed in 1872
(Customs Duties and Internal Revenue Taxes Act).
Between 1863 and 1871, the tax had contributed a total
of about $14.8 million to the Federal budget (see Table
2, Fiekowski, 1959). In an important victory, the Supreme Court upheld the constitutionality of the Federal
inheritance tax in Scholey v. Revenue Service (1874).
The court ruled that the inheritance tax was not a direct
tax, but an excise tax authorized by Article 1, Section 8
was also advanced in the debates surrounding the structure of the inheritance tax (Paul, 1954).
Inheritance Taxation and the Industrial Revolution
Table 2: Death Tax Receipts, Total Tax Receipts
in the United States, for Fiscal Years 1863-1871
Total tax
Death tax
Death taxes
receipts
receipts
as a percentage
(millions)
(millions)
of total taxes
1863
41.0
0.1
0.1%
1864
117.1
0.3
0.3%
1865
211.1
0.5
0.3%
1866
310.9
1.2
0.4%
1867
265.9
1.9
0.7%
1868
191.2
2.8
1.5%
1869
160.0
2.4
1.5%
1870
185.2
3.1
1.7%
1871
144.0
2.5
1.7%
Year
The repeal of the Civil War inheritance tax was
achieved with little public notice. However, inheritance
and the responsibility of government to ensure equal
opportunities for its citizenry would invoke intense debates by the close of the century. The postwar period
was one of unprecedented economic and population
growth. It was also one that saw enormous changes in
the American way of life. The industrial revolution was
at hand and, as Americans sought the fruits of mass production, the growth of industry spurred the development
of large urban centers and provided new jobs for both
natural born citizens and the ever increasing number of
immigrants (Bruchey, 1988).
The growth of industrial America and, with it, the
prosperity of entrepreneurs who pioneered in the creation of new products and services came at a time when
declining prices for agricultural products were hurting
American farmers in the West and in the South. The
wealth of the country became increasingly concentrated
in the hands of industrialists, as investments in stocks
began to supplant those in real estate. Because tariffs
and real estate taxes formed the basis of government
finances at the Federal and State levels, the burden of
supporting government fell disproportionately on farmers, while the wealth of the industrial giants was relatively untouched. These events brought about a series
of important political and social movements, including
a renewed discussion of the institution of inheritance
(Paul, 1954).
In Europe, the growing discontent with the concentration of national wealth in the hands of a relatively
few privileged families, and with the perpetuation of that
wealth through bequests, coincided with the rise of communism (Chester, 1982). In England, economist John
Stuart Mill (1929) urged limits on the rights of individuals to bequeath property to heirs. He argued that inheritance of property had its roots in feudal society where
land was used, but not owned, by the family. The death
of a family member had little effect on the use of the
land. This was not the case in “modern” society where
of the Constitution.
The 1864 Act, although altered by subsequent legislation, introduced several features, which later formed
the foundation of the modern transfer tax system. Some
of these features included the exemption of small estates, the taxation of certain lifetime transfers that were
testamentary in nature, and the special treatment of bequests to the surviving spouse. The idea of using tax
policy to encourage bequests to charitable organizations
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FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
grown children left their parents’ homes and pursued
independent lives and, therefore, no longer held a claim
on their parents’property. Mill, therefore, proposed “fixing a limit to what anyone may acquire by mere favor of
others without exercise of his facilities,” adding that “if
he desires any further accession of fortune, he shall work
for it” (Mill, 1994:35). Thus, Mill condoned a graduated tax on inheritances as a proper limiting mechanism.
In agreement with Locke and Bentham, he proposed
eliminating bequests to non-family members.
children a curse than the “almighty dollar” (Carnegie,
1962:21). The parent who leaves his son enormous
wealth generally deadens the talents and energies of the
son and tempts the son to lead a less useful and less
worthy life than he otherwise would, according to
Carnegie. He did not advocate leveling the wealth distribution, however. Rather, he strongly believed that
individuals should be encouraged to amass great wealth
and spend it, not on opulent living, but on important,
carefully planned works for the public good. Carnegie
also advocated a confiscatory inheritance tax, which, he
suggested, would force the wealthy to be more attentive
to the needs of the state--to use their money for noble
causes during their lifetimes. Dismissing arguments that
a large inheritance tax would diminish the incentive to
accumulate wealth, Carnegie maintained that, for the
class whose ambition it is to leave great fortunes, “it
will attract even more attention, and, indeed, be a somewhat nobler ambition, to have enormous sums paid over
to the State from their fortunes” (Carnegie, 1962:22).
In America, the populist movement was also calling for limits on inheritance and changes in tax laws to
make the very wealthy “pay their fair share.” Writers
such as Joseph Kirkland, Mark Twain, William Dean
Howells, and others were addressing the evils of capitalism and the plight of the farmer. Reformers such as
Joseph Pulitzer, publisher of the New York World, embraced the cause of the people rather than that of “purseproud potentates” (Paul, 1954:30). Pulitzer urged the
elimination of tariffs, since tariffs protected businesses
and their owners from competition and put the burden
of taxation disproportionately on consumers. That sentiment was echoed by many in Congress, including Congressman Henry George, who advocated an income tax
in “an attempt to tax men on what they have, not on
what they need” (Paul, 1954:31). Other reformers, such
as Charles Bellamy, a utopian socialist writing in 1884,
called for limits on inheritance, especially a limit on the
amount of property that could be distributed by will
(Chester, 1982). “Steep [inheritance] taxes ... would
decrease the number of social drones,” according to Professor Gustavus Meyer, author of The Ending of Hereditary American Fortunes. “Heirs would have less
funds to indulge in lavish expenditures, and the tax burden would be shifted from the laboring and consuming
public” (Office of Tax Analysis, 1963:7). Richard T.
Ely, author of Taxation in American States and Cities,
hailed the inheritance tax as a tax that was “in accord
with the principles of Jeffersonian Democracy and with
the teachings of some of the best modern thinkers on economic and social topics” (Office of Tax Analysis, 1963:7).
Defenders of material accumulation and of the right
to bequeath wealth to successive generations found refuge in the philosophy of Social Darwinism. Related to
the writings of the naturalist Charles Darwin, Social
Darwinism was first proposed in England by Herbert
Spencer and was later popularized by William Graham
Sumner in the United States. Foremost, Sumner argued
that government should not interfere with an individual’s
natural right to struggle for survival. Therefore, he saw
no problem with inequalities in the concentration of
wealth that arose through the course of that struggle.
Those who wanted either to limit the ability to accumulate wealth or to limit the amount of that wealth, which
might be passed on to future generations, were, according to Sumner, merely envious of the wealthy and had
no right to dictate social policy (Chester, 1982). Sumner
viewed a competitive economy as an essential component
of a democratic society. Indeed, the discipline imposed by
competition was viewed widely as a necessary mechanism
for the development of character (Bruchey, 1988).
Reformers achieved the passage of the Income Tax
Act of 1894. The value of all personal property acquired
by gift or inheritance was included in this graduated tax,
which had a top rate of two percent. Critics of the tax
heralded it as a blow to American democracy and pre-
One of the outstanding proponents of a substantial
Federal inheritance tax was industrialist Andrew
Carnegie. In his essay, “The Gospel of Wealth,” he advised that “the thoughtful man” would rather leave his
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dicted that it would ultimately lead to anarchy. Economist David A. Wells called it “a system of class legislation, full of the spirit of communism,” while the North
American Review called it the fulfillment of the “wildest socialist dream” (Paul, 1954:34). The income tax
was quickly appealed to the United States Supreme Court
in the case of Pollock v. Farmers Loan and Trust Company (1895) and declared unconstitutional as an
unapportioned direct tax.
Despite strong opposition, the inheritance tax was
made law by the War Revenue Act of 1898. A duty on
the estate itself, not on its beneficiaries, the 1898 tax
served as a precursor to the present Federal estate tax.
Rates of tax ranged from 0.75 percent to 15 percent,
depending both on the size of the estate and on the relationship of legatee to decedent (see Table 3). Only personal property was subject to taxation. A $10,000 exemption was provided to exclude small estates from the
tax; bequests to the surviving spouse were also excluded.
Estate Tax of 1898
In the case Knowlton v. Moore, the U.S. Supreme
Court declared the constitutionality of the 1898 inheritance tax. The 1898 Act was amended in 1901 to exempt certain gifts from inheritance taxation, including
gifts to charitable, religious, literary, and educational organizations and gifts to organizations dedicated to the
encouragement of the arts and the prevention of cruelty
to children (War Revenue Reduction Act, 1901). The
end of the Spanish-American War came in 1902, and
opponents of the tax wasted no time in exacting its repeal later that year (War Revenue Repeal Act, 1902).
Although short-lived, the tax raised about $14.1 million
(see Table 4, Fiekowsky, 1959).
In 1898, progressive reformers--still stinging from
the defeat of the Federal income tax--proposed a Federal death tax as a means to raise revenue for the Spanish-American War. Unlike the two previous Federal inheritance and probate taxes levied in times of war, the
1898 tax proposal provoked heated debate. Supporters
of the tax, including Congressman Oscar Underwood of
Alabama, used the debate to further their populist agenda.
“The inheritance tax is levied on a class of wealth, a
class of property, and a class of citizens that do not otherwise pay their fair share of the burden of government,”
Underwood said (Office of Tax Analysis, 1963:11).
However, conservatives, such as Congressmen Henry
Cabot Lodge and Steven Elkins, opposed the tax. They
suggested that the tax would force businesses to liquidate their assets and would destroy incentives to accumulate wealth, incentives which were essential to the
growth of capital markets (Paul, 1954).
Prelude to the Modern Estate Tax: 1900-1916
The years immediately preceding and following the
turn of the 20th century saw an unprecedented number
of mergers in the manufacturing sector of the economy.
T a b l e 3 : 1898 D e a th T a x R a te s
$10,000
$25,000
$100,000
$500,000
$1,000,000
under
under
under
under
or
$25,000
$100,000
$500,000
$1,000,000
m o re
Lineal issue, ancestors, siblings
0.75%
1.125%
1.50%
1.875%
2.25%
D e s c e n d a n ts o f siblings
1.50%
2.25%
3.00%
3.75%
4.50%
Uncle, aunt, a n d the ir descendants
3.00%
4.50%
6.00%
7.50%
9.00%
R e l a tionship
Great uncle, aunt, and their descendants
4.00%
6.00%
8.00%
10.00%
12.00%
All others
5.00%
7.50%
10.00%
12.50%
15.00%
N o te : Estates under $10,000 were exempt fro m the tax.
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FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
sive tax on all fortunes beyond a certain amount, either
given during life or devised or bequeathed at death. The
tax would be directed at “malefactors of great wealth,
the wealthy criminal class,” according to Roosevelt
(Paul, 1954:88). Later in 1906, he endorsed both an
inheritance tax and a graduated income tax. However,
he was unable to convince a majority of the Congress to
enact the reforms (Bittker, 1990).
Table 4: Death Tax Receipts, Total Tax Receipts
in the United States, for Fiscal Years, 1899 - 1902
Total tax
Death tax
Death taxes
receipts
receipts
as a percentage
(millions)
(millions)
of total taxes
1899
1900
273.5
295.3
1.2
2.9
0.5%
1.0%
1901
306.9
5.2
1.7%
1902
271.9
4.8
1.8%
Year
In 1909, newly elected President Taft, although unenthusiastic about an income tax, endorsed the inheritance tax. A special session of Congress was called in
March 1909 to address the revenue needs that had arisen
due, in part, to the bank panic of 1907. In that session,
Representative Sereno Payne, the Republican chairman
of the House Ways and Means Committee, proposed a
graduated inheritance tax. The tax was both correct in
principle and easy to collect, according to Payne (Paul,
1954). However, after the enactment of a corporate excise tax, the inheritance tax was dropped by the U.S.
Senate. Efforts to enact an income tax that year were
also derailed.
A new form of ownership, the holding company, caught
on and, by 1904, was responsible for 86 percent of large
mergers (Bruchey, 1988). The result of these mergers
was a concentration of wealth in a few powerful companies and in the hands of the businessmen who headed them.
Along with such wealth came great political power, and
the rise of plutocracy fueled the growth of the progressive movement into the early part of the 20th century.
The debate over the institution of inheritance, as well
as debate over the most suitable source of Federal revenues, continued until the passage of the 16th Amendment to the Constitution. With the 16th Amendment
came the enactment of the Federal income tax. The establishment of a national income tax served, at least temporarily, to pacify the public’s need to redress the inequalities in wealth, which arose as a result of America’s
industrialization (Office of Tax Analysis, 1963). However, the election of Woodrow Wilson in 1912 would
serve as a catalyst to the eventual passage of a permanent Federal estate tax.
The debate that had surrounded the enactment and
repeal of both the 1894 income tax and the 1898 inheritance tax gave new credence to the idea of Federal taxes
as a means of addressing societal inequalities. Under
the influence of Carnegie and others, the general public
accepted the notion that large inheritances lead to idleness and profligacy, states which contradicted their Puritanical world view. America was founded on the belief that each citizen should begin life with an equal opportunity to succeed and that the economic well-being
of the community required that each member earn his
or her own living (Bittker, 1990). The inheritance tax
was proclaimed an appropriate tool for ensuring the fulfillment of this manifesto.
In his inaugural address, President Wilson pledged
to ensure equality of opportunity for every American.
According to Wilson, government was an instrument to
be used by people to promote the general welfare (Paul,
1954). Espousing that view, he instituted a number of
reforms, including the Clayton Act (1914), which prohibited unfair labor practices, and the Federal Reserve
Act. Wilson also created the Federal Land Bank, which
made low interest loans to farmers. He opposed high
tariffs and, at the advent of World War I, he moved to
eliminate such tariffs on U.S. allies. The elimination of
By 1906, the progressive movement had an ally in
the White House. President Theodore Roosevelt, in his
annual message to Congress, endorsed an inheritance
tax and suggested that its “primary objective should be
to put a constantly increasing burden on the inheritance
of those swollen fortunes, which it is certainly of no
benefit to this country to perpetuate” (Bittker, 1990:3).
In the spring of that year, he again called for a progres-9-
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tariffs caused a loss of Federal revenue, a loss that was
amplified by the buildup of armaments and supplies following the sinking of the U.S. passenger ship Lusitania.
Facing a deficit of $177 million, Congress was forced
to find additional sources of revenue, and, once again, a
form of inheritance tax was considered a prime candidate (Office of Tax Analysis, 1963).
n The Modern Estate Tax
In May 1916, Representative Cordell Hull of Tennessee introduced a proposal for a Federal estate tax in
response to what he called “an irrepressible conflict”
between the rich and the poor. He suggested that, compared to the non-wealthy, the wealthy should pay a larger
share of the cost of government. Hull proposed an excise tax on estates prior to the transfer of assets to the
beneficiaries, rather than an inheritance tax. This, according to Hull, would form “a well-balanced system of
inheritance taxation between the Federal government and
the various States” and could be “readily administered
with less conflict than a tax levied upon the shares” (Paul,
1954:107). While an inheritance tax, with graduated
rates for each recipient, encourages greater dispersion
of the estate, the proposed estate tax eliminated the burden imposed by an inheritance tax on estates with fewer
beneficiaries (Bittker, 1990).
not available to nonresidents owning taxable property
in the United States. This relatively high filing threshold was adopted in deference to the right of States to tax
small estates. According to the Act of 1916, the gross
estate included all property, both personal and real,
owned by a decedent; life insurance payable to the estate; transfers made for inadequate consideration; transfers made in contemplation of death--within two years
of death; and transfers that took effect on or after death.
Also included in the gross estate was all joint property,
unless proof could be supplied supporting the contribution of the co-owner. A deduction was allowed for administrative expenses and losses, debts, claims, and funeral costs, as well as for expenses incurred for the support of the decedent’s dependents during the estate’s administration. The tax rates were graduated from one
percent on the first $50,000 of net estate to ten percent
on the portion exceeding $5 million. According to the
act, taxes were due one year after the decedent’s death,
and a discount of five percent of the amount due was
allowed for payments made within one year of death. A
late payment penalty of six percent was assessed unless
the delay was deemed “unavoidable.”
Understandably, reaction to Hull’s estate tax was
mixed. Having long advocated limits on inheritance,
prominent economists such as John A. Ryan, Richard
T. Ely, Wilford F. King, and E.R.A. Seligman supported
the estate tax. In contrast, the New York Times declared
the tax a “frank project of confiscation.” Harvard economist C.J. Bullock called it a “fiscal crime” (Paul,
1954:108). However, on September 8, 1916, Congress
enacted an estate tax that would survive, in large part, to
the present (Revenue Act of 1916).
The 1916 estate tax was appealed to the United States
Supreme Court in New York Trust Company v. Eisner.
The plaintiff argued that, unlike the earlier inheritance
taxes that applied only to the receipt of property, the
new estate tax was an infringement on the States’ right
to regulate the process of transferring property at death.
Justice Oliver Wendell Holmes, in upholding the tax,
reasoned that, “if a tax on property distributed by the
laws of a State, determined by the fact that distribution
has been accomplished, is valid, a tax determined by the
fact that distribution is about to begin is no greater interference and is equally good” (256 U.S.:348). Thus, the
Federal estate tax became a lasting component of the
Federal tax system.
The Revenue Act of 1916
Significant Tax Law Changes: 1916 to Present
The Federal estate tax was applied to net estates,
defined as the total property owned by a decedent, the
gross estate, less deductions. While a $50,000 exemption was allowed for all residents, the exemption was
Since its inception in 1916, the basic structure of
the modern Federal estate tax, as well as the law from
which it is derived, has remained largely unchanged.
However, in the eight decades that followed the Rev-
- 10 -
FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
enue Act of 1916, the U.S. Congress has enacted several important additions to, and revisions of, the modern estate tax structure (see Figure 1). There have also
been occasional adjustments to the filing thresholds, tax
brackets, and marginal tax rates (see Table 5). The first
such addition was a tax on inter vivos gifts, a gift tax,
introduced by the Revenue Act of 1924. The new tax
was imposed because Congress realized that wealthy individuals could avoid the estate tax, invoked at death,
by transferring wealth during their lifetimes. That is,
due to inter vivos giving, the estate tax’s inherent capacity to redistribute wealth accumulated by large estates was effectively circumvented, and a source of revenue was removed from the Federal government’s reach.
The Congressional response was a gift tax applied to
lifetime transfers.
the Revenue Act of 1948. Indeed, the estate tax marital
deduction, as enacted by the 1948 Act, permitted a
decedent’s estate to deduct the value of property passing to a surviving spouse, whether passing under the
will or otherwise (Zaritsky and Ripy, 1984). However,
the deduction was limited to one-half of the decedent’s
adjusted gross estate--the gross estate less debts and administrative expenses. In a similar manner, the gift tax
marital deduction allowed a “donor [spouse] to deduct
one-half of the interspousal gift, other than a gift of community property” (Zaritsky and Ripy, 1984:16). Further, the Act of 1948 introduced the rule on “split-gifts,”
which permitted a non-donor spouse to act as donor of
half the value of the donor spouse’s gift. The rule on
split gifts effectively permitted a married couple to transfer twice as much wealth tax free in a given year.
The first Federal gift tax was short-lived, however.
Due to strong opposition to estate and gift taxes during
the 1920’s, the gift tax was repealed by the Revenue
Act of 1926 (Zaritsky and Ripy, 1984). Then, just six
years later, when the need to finance Federal spending
during the Great Depression outweighed opposition to
gift taxation, the Federal gift tax was reintroduced by
the Revenue Act of 1932 (Zaritsky and Ripy, 1984). A
donor could transfer $50,000 free of tax over his or her
lifetime with a $5,000-per-donee annual exclusion from
gift tax.
With few other exceptions, the Congressional
Record remained free of reference to the estate tax and
the entire transfer tax system until the enactment of the
Tax Reform Act (TRA) of 1976. By creating a unified
estate and gift tax framework that consisted of a “single,
graduated rate of tax imposed on both lifetime gift and
testamentary dispositions” (Zaritsky and Ripy, 1984: 18),
the act eliminated the cost differential that had existed
between the two types of giving. Prior to the act, “it
cost substantially more to leave property at death than
to give it away during life” (Bittker, 1990:20) due to the
lower tax rate applied to inter vivos gifts. The Tax Reform Act of 1976 also merged the estate tax exclusion
and the lifetime gift tax exclusion into a “single, unified
estate and gift tax credit, which may be used to offset
gift tax liability during the donor’s lifetime but which, if
unused at death, is available to offset the deceased
donor’s estate tax liability” (Zaritsky and Ripy, 1984:18).
An annual gift exclusion of $3,000 per donee was retained.
The Revenue Act of 1935 introduced the optional
valuation date election. While the value of the gross
estate at the date of death determined whether an estate
tax return had to be filed, the act allowed an estate to be
valued, for tax purposes, one year after the decedent’s
death. With this revision, for example, if the value of a
decedent’s gross estate dropped significantly after the
date of death--a situation faced by estates during the
Depression--the executor could choose to value the estate at its reduced value after the date of death. The
optional valuation date, today referred to as the alternate valuation date, was later changed to six months after the decedent’s date of death.
Most outstanding among the pre-1976 changes to
estate tax law was the estate and gift tax marital deductions, as well as the rule on “split gifts” introduced by
The 1976 tax reform package also introduced a tax
on generation-skipping transfers (GST’s). Prior to passage of the act, a transferor, for example, could create a
testamentary trust and direct that the income from the
trust be paid to his or her children during their lives and
then, upon the children’s deaths, that the principal be
paid to the transferor’s grandchildren. The trust assets
included in the transferor’s estate would be taxed upon
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JOHNSON AND ELLER
Figure 1: Significant Tax Law Changes, 1916 - 1995
1916 - Estate tax enacted
1918 - Spouse's dower rights,
Exercised general powers of appointment, and
Insurance payable to estate and insurance
1924 - Gift tax enacted
over 40,000 to beneficiaries included
State death tax credit
Charitable deduction
Revokable transfers
included
1926 - Gift tax repealed
1932 - Gift tax reintroduced
Additional estate tax
1935 - Alternate valuation
1942 - Insurance paid for by decedent,
Powers of appointment (not limited) and
Community property unless spouse contributed
included
1948 - Marital deduction replaced
1951 - Powers of appointment rule relaxed
1942 community prop. rules
1954 - Most life insurance, unless decedent
never owned, included
1976 - Unified estate and gift tax
Generation-skipping transfer tax (GST)
Orphan deduction
Carryover basis rule
Special valuation and payment rules
for small business and farms
Increased marital deduction
1980 - Carryover rule repealed
1981 - Unlimited marital deduction
Full value pension benefits, but
only 1/2 joint property included
Orphan deduction repealed
1986 - ESOP deduction
GST modified
1987 - Phaseout of graduated rates and
unified credit for estates over
$10 million
1988 -QTIP allowed for marital deduction
Estate freeze and GST modified
1989 - ESOP deduction dropped
1990 - Estate freeze rules replaced
1995
- 12 -
FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
Table 5: Estate Tax Law Changes Affecting Filing Requirements and Tax Rates, 1916-1995
Basic tax
Year
Exemption Initial rate Top rate
Supplemental tax
Top bracket Exemption Initial rate Top rate
Top bracket
1916
50,000
1
10
5,000,000
1917
50,000
2
25
10,000,000
1918-23
50,000
1
25
10,000,000
1924-25
50,000
1
40
10,000,000
1926-31
100,000
1
20
10,000,000
1932-33
100,000
1
20
10,000,000
50,000
1
45
10,000,000
1934
100,000
1
20
10,000,000
50,000
1
60
10,000,000
1935-39
100,000
1
20
10,000,000
40,000
2
70
50,000,000
100,000
1
20
10,000,000
40,000
2
70
50,000,000
1941
100,000
1
20
10,000,000
40,000
3
77
10,000,000
1942-53
100,000
1
20
10,000,000
60,000
3
77
10,000,000
1954-76
60,000
3
77
10,000,000
120,000
18
70
5,000,000
1978
134,000
18
70
5,000,000
1979
147,000
18
70
5,000,000
1980
161,000
18
70
5,000,000
1981
175,000
18
70
5,000,000
1982
225,000
18
65
4,000,000
1983
275,000
18
60
3,500,000
1984
325,000
18
55
3,000,000
1985
400,000
18
55
3,000,000
500,000
18
55
3,000,000
600,000
18
55
3,000,000
1940
1977
a
b
1986
1987-95
c,
d
a. 10% war surtax added.
b. Unified credit replaces exemption.
c. Tax rate was to be reduced to 50% on amounts beginning in 1988, but was postponed until 1992,
then repealed retroactively in 1993 and set permanently to the 1987 levels.
d. Graduated rates and unified credits phased out for estates over $10,000,000.
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JOHNSON AND ELLER
the transferor’s death. Then, any trust assets included
in the grandchildren’s estates would be taxed at their
deaths. However, the intervening beneficiaries, the
transferor’s children in this example, would pay no estate tax on the trust assets, even though they had enjoyed the interest income derived from those assets.
Congress responded to the GST tax leakage in the Tax
Reform Act of 1976. The act added a series of rules,
applied to GST’s valued at more than $250,000, which
were designed to treat the termination of the intervening beneficiaries’ interests as a taxable event (Zaritsky
and Ripy, 1984). In 1986, Congress simplified the GST
tax rates and increased the amount a grantor could transfer into a GST tax free, from $250,000 to $1 million.
As with the gift tax exclusion, “married persons may
combine their [GST tax] exemptions, thus allowing the
couple a $2,000,000 exemption” (Bittker 1990:31).
Overall, the GST tax “ensures that the transmission of
hereditary wealth is taxed at each generation level”
(Bittker, 1990: 30).
The Economic Recovery Tax Act (ERTA) of 1981
brought several notable changes to estate tax law. Prior
to 1982, the marital deduction was permitted only for
transfers of property in which the decedent’s surviving
spouse had a terminable interest--an interest that grants
the surviving spouse power to appoint beneficiaries of
the property at his or her own death. Such property is,
ultimately, included in the surviving spouse’s estate.
However, the ERTA of 1981 allowed the marital deduction for life interests that were not terminable, as long
as the property was “qualified terminable interest property” (QTIP), defined as “property in which the [surviving] spouse has sole right to all income during his or her
life, payable at least annually, but no power to transfer
the property at death” (Johnson, 1994:60). To utilize
the deduction, however, the QTIP must be included in
the surviving spouse’s gross estate. The 1981 Act also
introduced unlimited estate and gift tax marital deductions, thereby eliminating quantitative limits on the
amount of estate and gift tax deductions available for
interspousal transfers.
The ERTA of 1981 increased the unified transfer
tax credit, the credit available against both the gift and
estate taxes. The increase, from $47,000 to $192,800,
was to be phased in over six years, and the increase would
effectively raise the tax exemption from $175,000 to
$600,000 over the same period (Johnson, 1990:20). The
ERTA of 1981 also raised the annual gift tax exclusion
to $10,000 per donee; an unlimited annual exclusion
from gift tax was allowed for the payment of a donee’s
tuition or medical expenses (Bittker, 1990). Finally,
through ERTA, Congress enacted a reduction in the top
estate, gift, and generation-skipping transfer tax rates
from 70 percent to 50 percent, applicable to transfers
greater than $2.5 million. The reduction was to be phased
in over a four-year period. However, later legislation-both the Deficit Reduction Act of 1984 and the Revenue Act of 1987--delayed the decrease in the top tax
rate from 55 percent to 50 percent until after December
31, 1992. Then, in 1993, Congress again revised the
top tax rate schedule, imposing a marginal tax rate of 53
percent on taxable transfers between $2.5 million and
$3 million and a maximum marginal tax rate of 55 percent on taxable transfers exceeding $3 million. The
higher rates were applied retroactively to January 1, 1993
(Legislative Affairs, 1993).
The Revenue Act of 1987, also called the Omnibus
Budget Reconciliation Act of 1987, introduced legislation to eliminate estate tax avoidance schemes known
as “estate freezes.” An estate freeze “involved division
of ownership of a business into two parts: a frozen interest and a growth interest” (Miller, 1988:1336). By
selling or giving away the growth interest, the interest
that held the potential for becoming valuable if the business prospered, “a taxpayer could maintain control of
the business and continue to enjoy the income from the
business while excluding any future appreciation in its
value from his gross estate” (Miller, 1988:1336). The
1987 legislation mandated treating the transferor’s frozen interest as a retained life estate in the growth interest that was transferred. Therefore, the growth interest
would be included in the owner’s gross estate upon his
or her death. In 1988, with the passage of the Technical
and Miscellaneous Revenue Act, Congress revised its
antifreeze legislation to include a different, and stricter,
approach toward the valuation of business interests transferred prior to death (Miller, 1988). These rules, however, proved to be too restrictive. The Revenue Reconciliation Act of 1990 repealed all prior estate-freeze legislation and, in its place, substituted strengthened gift
tax rules dealing with the valuation of the growth inter-
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FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
est at the time of the transfer. The 1990 Act also established specific rules for valuing the retained interest for
estate tax purposes (Johnson, 1994).
on U.S. Treasury bonds redeemed to pay these taxes is
exempt from taxation.
n Transfer Taxes and Estate Planning
Current Estate Tax Law
According to current estate tax law, a Federal estate
tax return must be filed for every deceased U.S. citizen
whose gross estate valued on the date of death, combined with adjusted taxable gifts made by the decedent
after December 31, 1976, and total specific exemptions
allowed for gifts made after September 8, 1976, equals
or exceeds $600,000. The estates of nonresident aliens
must also file if property held in the United States exceeds $60,000. All of a decedent’s assets, as well as the
decedent’s share of jointly owned and community property assets are included in the gross estate for tax purposes. Also considered are most life insurance proceeds,
property over which the decedent possessed a general
power of appointment, and certain transfers made during life that were (1) revokable or (2) made for less than
full consideration. An estate is allowed to value assets
on a date up to six months after a decedent’s death if the
value of assets declined during that period. Special valuation rules and a tax deferment plan are available to an
estate that is primarily comprised of a small business or
farm.
Expenses and losses incurred in the administration
of the estate, funeral costs, and the decedent’s debts are
allowed as deductions against the estate for the purpose
of calculating the tax liability. A deduction is also allowed for the full value of bequests to the surviving
spouse, including bequests in which the spouse is given
only a life interest, subject to certain restrictions. Bequests to charities are also fully deductible. A unified
tax credit of $192,800 is allowed for every decedent
dying after December 31, 1986. Credits are also allowed
for death taxes paid to States and other countries, as well
as for any gift taxes the decedent may have paid during
his or her lifetime. The estate tax return (Form 706)
must be filed within nine months of the decedent’s death
unless a six-month extension is requested and granted.
Taxes owed for generation-skipping transfers in excess
of the decedent’s $1-million exemption and taxes on
certain retirement fund accumulations are due concurrent with any estate tax liability. Interest accumulated
As the Federal transfer tax system has become more
complex, individuals have increasingly turned to estate
planners for tax minimization strategies. Estate planners, in turn, keep their clients apprised of tax law
changes, which may have an adverse effect on testamentary arrangements already in place. This has made
estate-planning more of a process than a one-time event.
Tax law provisions can have a significant impact on both
the ownership of assets during one’s lifetime and the
disposition of an estate at death. Occasionally, legislative intervention is specifically intended to influence
bequest patterns. Such was the case with the enactment
of the generation-skipping transfer tax. In other instances, changes in the tax code seeking to provide relief to specific segments of the population or those made
in response to revenue needs will have a bequest effect.
Allowable deductions, tax credits, and tax rates all play
a role in bequest decisions.
Tax law changes associated with the Economic Recovery Tax Act (ERTA), which applied to decedents
dying on or after January 1, 1982, provided for an unlimited deduction from the value of the gross estate for
bequests to a surviving spouse; prior to that, the deduction was limited to one-half the adjusted gross estate.
Figure 2 shows the full value of property bequeathed to
surviving spouses as a percentage of the decedents’distributable estates (total gross estate less expenses; debts;
and Federal, State, and foreign death taxes) for selected
years between 1972 and 1992. The percentage rises from
about 60 percent prior to 1982 to about 70 percent after
1982 and passage of ERTA. This suggests a significant
change in bequest behavior among married persons, with
more property passing to the surviving spouse and, perhaps, a reduction in the amount bequeathed to others,
including children and charities. Careful estate planning, however, may allow a decedent to take advantage
of tax avoidance strategies and maintain his or her bequest goals. A popular strategy is to form a trust known
as an “A-B trust.” Here, the estate planner creates one
trust in the amount of the decedent’s tax exemption
($600,000), sometimes called a Unified Credit Trust, and
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JOHNSON AND ELLER
puts the rest of the estate into a second, usually larger,
QTIP (Qualified Terminable Interest Property) trust.
Income from both trusts is directed to the surviving
spouse for life. However, the smaller trust is really set
aside for the children. The surviving spouse is typically
given more access to the principal of the second trust
and may have limited powers to appoint beneficiaries.
Upon the death of the second spouse, the remainder
passes to the children. Thus, the first decedent takes
advantage of the unlimited marital deduction but ensures
that the children will eventually benefit from the estate.
The value of property bequeathed to charities, as
well as the number of decedents making gifts to charities, declined after ERTA (see Figure 3). This may represent a shift in bequests from charities to the surviving
spouse as a result of the unlimited marital deduction. A
reduction in the top tax rate from 77 percent and increases in the unified credit since 1977 may also explain the decrease in charitable bequests. Studies of
charitable giving at death have shown that tax rates seem
to exert an influence on the size of charitable bequests,
as well as on the number of charitable organizations
named as beneficiaries (Joulfaian, 1991). This is so because the amount of tax savings attributable to the deduction decreases as rates decline. Charitable bequests
from decedents with relatively small- and medium-sized
estates seem particularly sensitive to changes in the rate
structure (Boskin, 1976; Clotfelter, 1985).
Federal estate taxes also encourage individuals to
begin transferring wealth well before death in order to
minimize the size of their estates. Lifetime giving may
be an important component of an individual’s overall
Figure 2: Marital Bequests as a Percentage of Distributable
Estate, 1972 -1995, for Married Decedents with Estates
of $600,000 or M ore in Constant 1987 Dollars
Percent
80
60
40
20
0
1972
1976
1982
1986
1989
1993
Filing year
Note: Distributable estate is total gross estate, less expenses, debts, and
Federal, State, and foreign death taxes.
- 16 -
1995
FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
Figure 3: Charitable Bequest Data, 1962-1995, for Estates of
$600,000 or More in Constant 1987 Dollars
Percent
25
Donors as a percentage of all filers
20
15
10
5
Bequests as a percentage of distributable estate
0
1962
1965
1969
1972
1976 1982
Filing year
1986
1989
1993
1995
Note: Distributable estate is total gross estate, less expenses, debts, Federal,
State, and foreign death taxes
bequest strategy. Federal gift tax law allows a donor to
make annual gifts up to $10,000 per donee without incurring a transfer tax liability; married couples are allowed up to $20,000 per donee. Children are usually
the primary recipients of these transfers. There are a
variety of trust instruments and financial arrangements
that may be used in conjunction with gift giving to remove assets from the estate. These affect the timing
and the amount of the tax liability, as well as the types
of assets and degree of ownership eventual beneficiaries receive.
the current transfer tax system, including estate, gift, and
generation-skipping transfer taxes, remains a topic of
Congressional, academic, and popular discourse. Further, the fundamental tenets of current discussions find
their roots in the historic arguments of early thinkers,
such as Adam Smith, David Ricardo, and Jeremy
Bentham. Although the transfer tax system is often cited
as a negative influence on the accumulation of capital
stock in the U.S. economy, as well as a negative influence on the vitality of small business, the system is preserved in a form that differs little from its origins.
n Current Transfer Taxation: Criticisms
and Proposals
The scope of the transfer tax system, as measured
by Federal revenue flows, is quite narrow. While it is
reasonable to argue that a Federal tax is levied, at least
in part, for its contribution to Federal budget inlays, the
revenue derived from estate and gift taxes does not contribute significantly to total budget receipts. “Taxes on
Eight decades since the introduction of the modern
Federal estate tax, and two centuries since discussions
of inheritance and taxation first appeared in America,
- 17 -
JOHNSON AND ELLER
property transfers have never provided significant revenues in this country and have been reduced to an insignificant proportion in recent years,” according to economist Joseph A. Pechman, former senior fellow at the
Brookings Institution (1983:226; see Figure 4). With
few exceptions, revenue from Federal estate and gift
taxes has lingered between one and two percent of Federal budget receipts since World War II, reaching a postwar high of 2.6 percent in 1972. Recent data also demonstrate the small role that transfer taxes play as sources
of Federal revenue. In 1994, as well as in the preceding
four years, Federal estate and gift taxes made up only
one percent of budget receipts.
The scope of the transfer tax system, as measured
by the size of the population directly affected by the
system, is also quite narrow (see Table 6). The number
of estate tax filers with taxable estates--filers who incurred a tax liability--reached a high of 139,115 in 1976;
the estate tax exemption in that year was $60,000. Since
the introduction of the $600,000-estate and gift tax exemption in 1987, the annual number of taxable estate
tax returns has not exceeded 32,000. In 1994, 31,918
taxable estate tax returns were filed for decedents, a number that represents only 1.4 percent of the adult deaths
that occurred in that year, according to preliminary 1994
death statistics by the National Center for Health Statistics (see Table 6 footnote). The number of estate tax
decedents with tax liabilities during 1995 was 31,692.
Preliminary estimates for the number of adult deaths for
1995 are not available.
Clearly then, the transfer tax system neither provides
a significant portion of Federal budget inlays nor subjects a significant portion of the U.S. population to Federal taxation. For these and other reasons, the system is
the object of much criticism. The assertion that the estate tax is a “voluntary tax,” a term first employed by
Figure 4: Estate and Gift Taxes as a Percentage of Total Federal
Receipts, 1917-1995
Percent
10
8
6
4
2
0
1920 1925 1930 1935 1940 1945 1950 1955 1960 1965 1970 1975 1980 1985 1990 1995
Filing year
- 18 -
FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
Table 6: Estate Tax Returns as a Percentage of Adult Deaths,
Selected Years of Death, 1934-1993
(Starting with 1965, number of returns is based on sample estimates)
Taxable estate tax returns
Selected year
Total
of death
adult deaths a
Number
of adult deaths
(1)
(2)
(3)
983,970
1,172,245
1,257,290
1,237,585
1,181,275
1,205,072
1,237,186
1,216,855
1,211,391
1,277,009
1,238,917
1,239,713
1,278,856
1,283,601
1,285,684
1,304,343
1,237,741
1,332,412
1,289,193
1,358,375
1,426,148
1,483,846
1,578,813
1,796,055
1,854,146
1,819,107
1,897,820
1,945,913
1,968,128
2,015,070
2,033,978
2,053,084
2,096,704
2,079,035
2,079,034
2,101,746
2,111,617
2,168,120
8,655
9,137
12,010
13,220
12,720
12,907
13,336
13,493
12,726
12,154
13,869
18,232
19,742
17,469
17,411
18,941
24,997
25,143
32,131
38,515
45,439
55,207
67,404
93,424
120,761
139,115
34,446
34,883
30,447
22,324
21,939
18,059
20,751
23,002
24,456
26,277
27,243
32,002
0.88
0.78
0.96
1.07
1.08
1.07
1.08
1.11
1.05
0.95
1.12
1.47
1.54
1.36
1.35
1.45
2.02
1.89
2.49
2.84
3.19
3.72
4.27
5.20
6.51
7.65
1.82
1.79
1.55
1.11
1.08
0.88
0.99
1.11
1.18
1.25
1.29
1.48
1934
1935
1936
1937
1938
1939
1940
1941
1942
1943
1944
1946
1947
1948
1949
1950
1953
1954
1956
1958
1960
1962
1965
1969
1972
1976
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993 b
Percentage
a. Total adult deaths represent those of individuals age 20 and over, plus deaths for w hich age w as unavailable.
For 1993, total deaths are for adults age 25 and older and for the 12-month period ending w ith November.
b. Preliminary
SOURCE: For years after 1953, STATISTICS OF INCOME-ESTATE TAX RETURNS; ESTATE AND GIFT TAX RETURNS;
FIDUCIARY, ESTATE, AND GIFT TAX RETURNS; and unpublished tabulations, depending on the year. For years prior
to 1954, STATISTICS OF INCOME - PART I. Adult deaths are from the National Center for Health Statistics, Public
Health Service, U.S. Department of Health and Human Services, VITAL STATISTICS OF THE UNITED STATES, unpublished tables.
- 19 -
JOHNSON AND ELLER
Columbia law professor George Cooper in his 1979 study
of estate-planning techniques, is foremost among the
criticisms of the tax. By labeling the estate tax “voluntary,” Cooper suggests that, far from imposing an unavoidable tax, estate tax law really provides numerous
methods for tax avoidance. Today, tax avoidance
schemes fall into three basic categories. First, the “technique of estate freezing keeps free of tax the future
growth in an individual’s wealth by diverting that growth
to the next generation” (Cooper, 1979: 4). Second, the
“creation of tax-exempt wealth takes advantage of special provisions in the tax code that exempt certain assets
from taxation” (Cooper, 1979:4). Finally, the “reduction or elimination of tax on existing wealth is made
possible by a package of techniques for gift-giving,
manipulating valuations, and exploiting charitable deductions” (Cooper, 1979:5). Cooper concludes that,
“because estate tax avoidance is such a successful and
yet wasteful process, ... the present estate and gift tax
serves no purpose other than to give reassurance to the
millions of unwealthy that entrenched wealth is being
attacked” (82), reassurance which, he later suggests, is
merely superficial. The annual costs of estate tax avoidance schemes, including lawyer fees, accountant fees,
costs of subscriptions to estate planning magazines, and
opportunity costs of individuals involved in tax avoidance activities, have been shown to represent a large
percentage of the annual receipts from estate and gift
taxes. A 1988 study showed that tax avoidance costs
approach billions of dollars annually, which, according
to the study’s researchers, represent “an inordinately high
social cost for a tax that only yielded $7.7 billion in 1987”
(Munnell, 1988:19).
Our present system of taxing wealth transfers is also
criticized for its effect on capital accumulation in the
U.S. economy. In his examination of the Federal transfer tax system, Richard Wagner (1993), professor of
economics, suggests that, “by reducing the incentive that
people have to save and invest, transfer taxation reduces
capital formation, which, in turn, reduces wages and job
creation from what they would otherwise be” (6). This
argument echoes one asserted by Adam Smith in the
late 18th century and David Ricardo in the early 19th
century. Indeed, according to both of these early economists, transfer taxes decrease investment in capital and,
thereby, decrease productivity and wages as heirs are
forced to liquidate business assets to pay the tax. In his
study of the social costs of transfer taxation in the United
States, Wagner estimated that, in the absence of Federal
transfer taxation since 1971, jobs would have increased
by 262,000, capital investment would have increased
by $399 billion, and gross domestic product would have
increased by $46 billion.
Federal transfer taxes are often cited as impediments
to the livelihood of small businesses and farms. Indeed,
“small businessmen and farmers have always felt that
the estate tax is especially burdensome” (Pechman,
1983:242), given that their estates may consist of little
more than their businesses. These businessmen, and their
Congressional representatives, assert that “heavy taxation or a rule requiring payment of taxes immediately
after the death of the owner-manager would necessitate
liquidation of the enterprise and loss of the business by
the family” (Pechman, 1983:242). Congress has responded to such concerns by introducing certain taxrelief provisions. In 1976, for example, Congress suggested that “additional relief should be provided to estates with [liquidity] problems arising because a substantial portion of the estate consists of an interest in a
closely held business or other illiquid assets” (Senate
Report, 1976). Thus, in 1976, Code Section 6166 was
passed. Under 6166, an executor is permitted to “elect
to pay the Federal estate tax attributable to an interest in
a closely held business in installments over, at most, a
14-year period” (Beerbower, 1995:5).
During 1995 and 1996, the impact of estate taxation
on small business, and other estate tax issues, including
the very existence of the tax, were once again topics of
discussion in Congress, as well as in the 1996 Presidential election. Several bills addressing the Federal estate
tax were introduced during the 104th Congress, 19951996. In April 1995, the U.S. House of Representatives
passed one such bill, H.R. 1215, a proposal to increase
the unified credit against the estate and gift tax, as well
as to provide a cost-of-living adjustment for such credits (U.S. Library of Congress, 1996). In addition, the
bill proposed to provide an “inflation adjustment for the
alternate valuation of certain farm and business property, the gift tax exclusion, the generation-skipping tax
exemption, and the estate tax on closely held businesses”
(Library of Congress, 1996). The bill called for a gradual
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FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
rise in the unified credit and, therefore, a gradual rise in
the effective exclusion for estate and gift tax purposes,
from the current $600,000 to $700,000 in 1996, $725,000
in 1997, and $750,000 in 1998, after which the exclusion would be adjusted for inflation. Although the Senate Finance Committee held hearings on the measure,
the Senate did not pass a bill.
Congress submitted other similar bills during its
104th session. H.R. 62, while never passed, sought “to
increase the unified estate and gift tax credit to an amount
equivalent to a $1,200,000 exemption” (Library of Congress, 1996). The Senate considered S.628, the Family
Heritage Preservation Act. That bill proposed a complete repeal of Federal estate, gift, and generation-skipping transfer taxes. While introducing the bill to the
legislative body, the senate sponsor of S.628 called the
Federal estate tax “one of the most wasteful and unfair
taxes currently on the books,” further suggesting that
the tax “penalizes people for a lifetime of hard work,
savings, and investment.” The tax “hurts small business and threatens jobs ... {and} causes people to spend
time, energy, and money finding ways to avoid the tax,”
said the senate sponsor.
The 1996 Presidential election also served as a forum for discussion of the Federal estate tax. The need
for estate tax relief was among the campaign themes of
Republican presidential nominee Robert “Bob” Dole.
At a campaign rally in Alamogordo, New Mexico, in
early November 1996, Dole addressed the tax on death
transfers. “[F]or those who work all their lives--kids
work, the wife works, the husband works, you scrimp
and save, and you finally have a little business or a little
farm or a little ranch, and somebody passes on,” Dole
said, according to the Federal News Service. “We don’t
think you should have to sell part of the ranch to pay the
estate taxes. We’re going to start providing estate tax
relief,” he added. Dole and his running-mate, Jack
Kemp, outlined a 14-point pledge that contained a promise to “increase the estate tax exemption from $600,000
to $1.6 million and eventually eliminate the estate tax
on family-owned businesses, farms, and ranches,” according to U.S. Newswire.
During the first term of his administration, President Bill Clinton supported modification, not the com-
plete elimination, of the Federal estate tax. At hearings
before the Senate Finance Committee in June 1995, thenDeputy Assistant Secretary of Tax Policy at the Treasury Department, Cynthia G. Beerbower, said that the
Clinton administration “recognizes that the levels of the
unified credit and various other estate and gift tax limitations have not been increased since 1987” (Beerbower,
1995:5). The administration is “willing to work with
Congress to maintain an estate and gift tax system that
exempts small- and moderate-sized estates, and that helps
keep intact small and family businesses, so that they can
be passed on to future generations” (1995:6), according
to Beerbower.
In November 1996, the Clinton administration won
a second term in office, and the Republicans retained
the majority in Congress. These events, and recent negotiations about filing thresholds, tax brackets, and marginal tax rates in the Federal transfer tax system, suggest that the system will continue to find a place in national dialogue.
n Conclusion
Today, some tax theorists work to convince Congress that transfer taxes should play a larger role in the
Federal revenue system because, they argue, “death taxes
have less adverse effects on incentives than do income
taxes of equal yield” (Pechman, 1983:225). Indeed,
“income taxes reduce the return from effort and risk taking as income is earned,” according to Pechman, whereas
“death taxes are paid only after a lifetime of work and
accumulation and are likely to be given less weight by
individuals in their work, saving, and investment decisions” (1983:226). There are economists who also reject the postulate that moderate transfer taxes have an
adverse effect on capital accumulation. Embracing an
idea first proposed by the mid-19th century English
economist J.R. McCulloch, they argue that transferors
adjust their bequest plans when faced with transfer taxes
(Fiekowski, 1959). According to McCulloch, the death
tax causes individuals who plan to make significant bequests to increase savings so that their heirs can pay the
taxes without adversely affecting the transferred assets.
When transfers involve business assets, McCulloch
might have argued, a testator would ensure the continu-
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JOHNSON AND ELLER
ance of a business by increasing the bequest amount in
order to cover the cost of transfer taxes.
Still, Congress and the public seem hesitant to increase the scope of the transfer tax system. “The equalization of the distribution of wealth by taxation is not
yet accepted in the United States,” suggests Pechman
(1983:227). Chester (1982) attributes this to what he
calls the “lottery phenomenon: the strong desire of the
majority of Americans to have a chance to ‘win big’ by
inheriting wealth, thus vaulting without exertion above
the mass of men” (51). Pechman also suggests that
misconceptions regarding the scope of transfer taxes may
also be a factor. “[E]state and gift taxes are erroneously
regarded as especially burdensome to the family that is
beginning to prosper through hard work and saving,”
according to Pechman, who further suggests that “the
merits of wealth transfer taxes will have to be more
widely understood and accepted before they can become
effective revenue sources” (1983:227).
More than 300 years after John Locke and his contemporaries sought to define the relationship between
civil government and the governed, Americans struggle
for consensus concerning government’s ideal role in the
regulation of wealth transfers. There is resentment over
the use of transfer taxes as a source of revenue and as a
tool for influencing the distribution of personal wealth.
There is also the belief that the revenue and redistributive goals of transfer taxes are entirely appropriate to an
altruistic nation that promotes the welfare of its citizens.
Even economists are divided. Neoclassical economists
assert that the disruption to businesses resulting from
transfer taxes has cost the economy billions of dollars
in lost productivity and hundreds of thousands of new
jobs. Yet, many tax economists argue that transfer taxes
are less harmful than income taxes and have great appeal “on social, moral, and economic grounds”
(Pechman, 1983:226). Disputes over the economic effects and propriety of transfer taxes have spanned many
centuries, and the fervor on which those disputes are
founded is no less present today.
G. Beerbower, Deputy Assistant Secretary (Tax
Policy) Department of the Treasury, before the
Senate Finance Committee, Washington, D.C.:
Office of Public Affairs.
Bittker, I. and Clark, E. (1990), Federal Estate and
Gift Taxation, Boston, MA: Little, Brown, and
Company.
Boskin, M.J. (1976), Estate Taxation and Charitable
Bequests, Journal of Public Economics, 5, 27-56.
Bruchey, S. (1988), The Wealth of the Nation, New
York: Harper and Row.
Carnegie, A. (1962), The Gospel of Wealth and Other
Timely Essays, Cambridge, MA: The Belknap
Press of Harvard University Press.
Chester, R. (1982), Inheritance, Wealth, and Society,
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Clotfelter, C.T. (1985), Federal Tax Policy and
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n References
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FEDERAL TAXATION OF INHERITANCE AND WEALTH TRANSFERS
Internal Revenue Law of 1864 §124-150, 13 Stat. 285.
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JOHNSON AND ELLER
Wagner, Richard E. (1993), Federal Transfer Taxation: A Study in Social Cost, Costa Mesa, California: Center for the Study of Taxation.
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SOURCE: "Inheritance and Wealth in America",
editor; Robert K. Miller Jr., and Stephen J.
McNamee, Plenum Press, NY, 1998.
NOTE: Views expressed in this paper are those of
the authors and do not necessarily repesent the
views of the Treasury Department or the Internal
Revenue Service.
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This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.