The federal government imposes taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. es on wealth transfers through its unified transfer tax system. The unified system is comprised of three parts: an estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. , a gift taxA gift tax is a tax on the transfer of property by a living individual, without payment or a valuable exchange in return. The donor, not the recipient of the gift, is typically liable for the tax. , and a generation -skipping tax .An estate tax is paid on the contents of estates. Transfers of wealth between living persons are subject to the gift tax. Transfers to grandchildren or more distant descendants are subject to the generation-skipping transfer tax.
The federal government did not rely on transfer taxes as a permanent source of revenue for most of the nation’s history. Rather, such levies were used as temporary sources of revenue during national emergencies. This pattern changed in 1916 when, along with instituting the income tax, the federal government enacted an estate tax. Sixteen years later, largely to prevent avoidance of the estate tax, it enacted a gift tax.
A series of legislation passed in 1976, 1981, and 1986 overhauled and modified the federal transfer tax system. Portions of the separate estate and gift tax systems were unified and levies were imposed on generation-skipping transfers. These Acts also lowered marginal transfer tax rates and significantly reduced the number of transfer tax returns filed each year by raising the filing requirements.
Prior to the 1976 Act, estate taxes were paid by approximately seven percent of estates in any given year. After 1987, the estate tax was paid by no more than three-tenths of one percent in a given year.
Two recent tax Acts have partially reversed some of the changes made by the 1976, 1981, and 1986 Acts. The Omnibus Budget Reconciliation Act of 1987 extended until 1992 the top marginal rate of 55 percent. This rate had been scheduled to fall to 50 percent. By enacting an additional 5 percent tax on transfers between $10 million and $21.04 million, the Act also phased out the benefits of the unified credit and graduated rate schedule over this range. These provisions had expired on December 31, 1992. They were retroactively reinstated, however, when President Clinton signed the Omnibus Budget Reconciliation Act of 1993.
With the exception of the mid -1930’s, transfer taxes have never represented a significant share of federal revenue. In 1992, the U.S. government collected $11.1 billion in transfer taxes, predominately estate taxes, representing about 1 percent of total federal revenue.
In 1993, the combined effect of the unified credit, graduated rate schedule, and benefit phase out rule was to create a range of effective marginal and average transfer tax rates that differed markedly from the statutory schedule. For example, while the statutory marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. on transfers between $600,000 and $1 million was 37 percent, the effective average tax rateThe average tax rate is the total tax paid divided by taxable income. While marginal tax rates show the amount of tax paid on the next dollar earned, average tax rates show the overall share of income paid in taxes. on such transfers ranged from 0 percent to 15.3 percent.
An examination of estate tax returns filed for 1989 decedents, the latest year for which such data is available, reveals that estate taxes paid by estates whose gross value exceeded $1 million accounted for nearly 96 percent of the total federal estate tax receipts, though they represented less than one half of all such returns filed.
The value of the wealth reported on the estate tax returns filed for 1989 decedents totaled almost $87.7 billion. The lion’s share of this wealth, 31 percent, or slightly over $27.2 billion, was held by estates valued between $1 million and $2.5 million. The next largest share, 22.8 percent or $19.9 billion, was held by estates valued at between $600,000 and $1 million. Estates valued over $20 million held 14.1 percent of this wealth, or $12.3 billion.
About 250 large estates (estates with over $20 million) file with the IRS each year. These estates are composed largely of business assets, such as closely held stock, farm assets, limited partnerships, and other non-corporate businesses. This implies that, very often, most of the wealth held in large estates is the life work of successful entrepreneurs and farmers, what might safely be termed “first generation wealth.” These estates pay the highest tax rates and most tax per estate. Because many of the largest estates primarily comprise first generation wealth, and these estates pay the highest estate tax rates, it appears that it is here that the transfer tax system has its most deleterious effect on the economy by falling most heavily on the estates of successful entrepreneurs, some of the nation’s most economically productive citizens.Share