Tax of Estates, Trust and Gifts
The Estate tax gives one the right to transfer property after death. It comprises an account of everything owned by the diseased and everything he or she had an interest in at the day of death. In the valuation of these items, the fair market value is used, that means the price paid for the item at the time they were acquired is not used to value them. The total valuation is referred to as Gross Estate, which may in include cash and securities trusts, business interests among others. Deductions like mortgages and debts are made on Gross Estate to arrive at taxable Estate. The lifetime taxable gifts made from 1977 as stated in the law are added to the computed net Estate, and tax is calculated (Kopczuk, 2012). Using the available unified credit, the tax is reduced. The accumulated taxable gifts are added to the taxable estate to derive the estate tax liability.
The gift tax was first enacted as a measure to protect and minimize avoidance of estate and income tax. Gift tax is in any property transferred by one individual to another in cases where: the donor expects nothing in return, expects a return of something that is less than the full value of property transferred, or where an interest free loan is allowed or interest of loan reduced, in which case is referred to as a gift.
Trusts are divided into three types depending on their responsibilities. The first type is a settlor. This is the person who puts assets into trusts. The second type is a trustee which is the person that takes care of the assets and finally the beneficiaries if trust. These types are taxed separately and distinctively. Beneficiaries pay tax on distributions received from trust’s income. This is practiced when the current income to be distributed is not distributed currently to the beneficiaries. Trusts and estates are channeled to the beneficiaries of income distributed currently or as income required to be distributed currently.
History of Tax of Estates, Trust and Gifts
Properties used to be taxed dating back to Roman Emperor Caesar Augustus time. Taxes were imposed on succession and legacies to everyone including the relatives of the diseased. It is this type that Europe used to tax property when a member of family died. This went on until 18th century where registration fees and duties on wills, stamp and inventories and all other documents related to property transfers upon death started to be practiced by other nations including the United States of America. As Joulfaian (2013) states, previously, the United States did not have a regular system of taxing gifts and estates. This is because the federal government only searched on new ways of accumulating revenue whenever there were projects that that presses the government to provide more revenue. An example was during the times of war. The adoption of taxing property transfers at death in the 18th century was necessitated by strained trade relations with France on the development of naval force.
A system of stamp duties came up from recommendations made by a committee that was in charge of revenue collection. The main reason for this system was fill the existing demand for more revenue. The items recommended by committee to bear taxes were inventories of the deceased, the personal assets received and shared legacies and finally probate wills and letters of administration. The committee had recommended tax be imposed on inventories of deceased persons, on receipts of shares of personal estates and legacies, and finally on letters of administration and probates of wills. The recommendations had proposed such taxes not to extend to wives, children, and grandchildren. The tradition of taxing assets in United States started with the Stamp Act enacted in 1797. Federal stamps were supposed to be put on wills offered for probate and also on letters of administrations and inventories. The stamps were also required on discharges and receipts from the intestate distribution of property and legacies.
The set of pattern of using estate tax as sporadic and temporary way of financing wars continued for about 100 years. The tax act was repealed to help finance the civil war. The first federal gift tax was introduced in the Revenue Act of 1862. This Act included some elements of federal estate and gift tax that are still applicable today. The Act was to first consider special treatment of charitable transfers. It also imposed a tax on federal inheritance. In 1866, the pleas of the special commissioner of revenue to put restrictions on legacy and succession taxes were responded by Congress, and a penalty of up to $1,000 was imposed on administrators and executors upon failure to file required statements or for filing false statements. The taxes were then repealed in 1870 after the need for additional revenues ceased.In1894; the court observed that, imposing an income tax on gains from real estate burdened the real estate as to establish a direct tax, which had to be allocated in different states in accordance with the census. Consequently, it abolished the whole statute because it realized, eliminating the tax on real estate income alone would heavily burden other classes of taxpayers, which contrasted the intentions of the Congress.
In the early 20th century, the trade tariffs were reduced due to worldwide conflicts. The Congress was forced to turn to another source of revenue. This was when the modern day income tax was introduced in the Revenue Act of 1916. The Act included estate tax with many elements found in the system today. Estate taxes increased especially when the U.S entered the World War 1(Kopczuk, 2016). The figure wasn’t reduced even after the war ended but instead the Congress increased rates and introduced a gift tax in 1924.These tax rates were imposed so as to prevent accumulation of wealth in the hands of a few. In 1954 the internal revenue code made provisions to increase the types of properties to be taxed. The main target was inclusion of most earnings from life insurance which would have raised the amount tax collected from Estates.
Since 1976, the federal transfer taxes have been reviewed and proposals incorporated into the system which has borne the present day tax system. All the previous tax reforms that tried to close the loopholes in the Tax Act gave us the current system. The most significant change is that which combined the taxes previously exempted for estates with the gift taxes into a unified estate and gift tax credit. The Tax Relief Reconciliation Act in conjunction with Economic Growth Act, tried to eliminate the death tax in 2001. It advocated for an increase in unified credit in order to schedule for phase-out of rates, which was repealed in the tax calendar of 2010. Unfortunately, these provisions were discharged in 2011 reverting the Estate tax back to 1997 law.
Characteristics of Tax of Estates, Trust, and Gifts
Estate, trust and gift tax have major characteristics that distinguish them from each other. The estate and gift tax have been combined to form a single tax transfer called Federal Estate. According to Bloom (2015), for the Estate tax to work, the executor must file the Federal estate tax return within a period of nine months after the death of a person if the gross estate exceeds the exempted amount which is $5.43 million. The estate tax is imposed on the gross estate of the diseased, which include both financial assets like stocks and bonds, and real assets like homes and land. It is also comprised of shares owned by the descendants in jointly owned assets like life insurance. The Estate tax allows deductions like charity, to be made on the transfers made to a surviving spouse. Other deductions like funeral expenses and debts are also allowed upon which the taxable estate is equivalent to the remaining gross estate after these deductions. There is a credit exemption for a gross estate amount of up to $5.43 million in which a top rate of 40% is applied on the extra value exceeding that amount.
Earlier on before Gift taxes were enacted, it was observed that donors transferred their assets before their death, a strategy that was used to avoid the estate tax. To prevent this, they federal government brought into existence the Gift tax. Gift tax to a large extend, share similar features with the Estate tax. Just like the Estate Tax, a lifetime exemption of $5.43 million is provided per donor. Any value exceeding that exemption is taxable where donors pay gift tax at a top rate of 40%.Each year, an additional amount of $14,000 is exempted from both gift tax and the lifetime exemption (Chirelstein & Zelenak, 2015). This exemption is valued in relation to inflation, and it is imposed to each recipient separately.
Apart from same tax rate schedule Gift Tax and Estate Tax share, they are both joined into one unified tax system which reduces the tax liability of an individual. This is the credit allowed for the portion of the tax imposed on a taxable estate. For example, one can take advantage of the unified credit if the taxable estate goes beyond the exempted amount in a particular year. Unified credit allows the donor to transfer $5 million together with annual adjustments for inflation during their lifetime without paying tax. However, using unified tax while still alive, reduces the amount one can offset the estate tax at the time of death. Estate and gift tax also have charitable and marital deductions to reduce the liability of tax. Computation of both gift and estate tax is accounted throughout the life of a person.
New regulations and Applications of Tax of Estates, Trust, and Gifts
There has been continued effort of enacting new regulations of these taxes intended to promote fairness and relevance of property transfer fees. Though reviews are undertaken time to time which are still ongoing, there has been a significant result of changes made so far. For example, there are special provisions on the Estate tax law that reduce the tax or spread payments over time for the businesses closely held together by family and for lands owned by the family. When the conditions are fully satisfied, the taxable value can be reduced by up to 40 to 70 percent. For farms and businesses making up to 35% of the gross estate, tax payable can be spread in installments for more than 14 years at reduced interest rates, and interests set to be applicable for only the first five years.
Estates and Trusts have been separated as different entities of fiduciaries which are taxed differently. These assets are categorized under the same legal title called judiciary who distributes them to the beneficiaries named. A trust is treated as a separate individual when imposing a tax. Trust itself gets taxed as if the income was earned by a different person other than the settlor, beneficiary or trustee. Immediately property transfer in a trust is made, a settlement is set to where capital gains accrued results into taxes after 21 years which results in taxes accrued on capital gains. This settlement is referred to as ‘21 year rule’ is set to prevent the tax on capital gains accumulated on a property of trust from being postponed indefinitely. The rule puts the beneficiary responsible for all gains on the property until he or she disposes of the property. The top personal marginal rate of up to 55% is taxed on income received from an Inter Vivos trust. The 2015 new regulation provides a graduated marginal tax rate which imposes lower tax rate for testamentary trust on approximately the first $138,000 trust income (McGarry, 2013). However, this graduated rate taxation only applied in 2015.From 2016, it is limited to the first 36 months of an estate after the day the person dies and only applicable to testamentary trusts who have at least one beneficiary eligible for the credit given on federal disability tax.
According to Crawford (2016), the estate and gift tax exemptions have been revised and raised to $5.45 million per person in 2016 .Therefore people can transfer assets worth this amount to their families and be exempted from federal estate taxes and gift tax. Consequently, a married couple will be able to transfer property worth $10.9 million free from tax. But the annual gift exclusion remains the same. Any person can rely on the advanced property transfer strategies and minimize tax charged on gifts by taking advantage of the annual exemption, valuation discounts and lifetime exemptions as stipulated by the law. One of these strategies is taking advantage of the annual exclusion and channeling payment directly to educational or medical providers on behalf of loved ones. This federal estate and gift tax exemptions are set to rise with inflation.
The legislations enacted on Estate and Trust Tax are still severe than those on gift tax, For example, the new Medicare tax on investments income in high tax bracket makes trusts and estates to pay more taxes on incomes. Income taxation of estates and trusts has been receiving little attention from tax professionals, lawmakers, and the public as well. This is by comparing it with the estate and gift tax which has been regularly debated by the professional community, the government, and the public. As a result, the practitioners and their clients may be unaware of any issues affecting the estate and trusts. This can even explain the reason why comparatively few taxpayers were affected recently as revealed by the U.S Statistics of income. To add on ,when the legislation enacted by the Economic Growth and Tax Relief Reconciliation Act of 2001 are incorporated together with the recent legislative proposal calling for the strategies to scale back the estate tax, the gift tax remains to a large extend unaffected. The estate tax may face an uncertain future while gift tax remains part of the tax code for the foreseeable future.
The way estate tax in administered does not favor incentives to invest and save thus hampering economic growth. When combined with income taxes, estate taxes raise the tax rate on income from assets as compared to income from working. The Estate tax is also unfair to families who own farms or businesses. Even though tax is based on the value of asset, the beneficiaries still pay out of their income. The Estate tax, therefore, stands an unfriendly provision in the tax system In order to reduce the proportion of assets taxable to be more in line with the 1920s and 1930s; the exemption amount should be increased to even up to $10 million. However, this would partly address the impact of the tax. As indicated in the unified credit tax statute, raising exemption amount would lower marginal rate and this would make the tax less efficient. Reducing the tax on assets pushes the rates high thus increasing the ratio of marginal to average rate. Maybe converting exemption from credit to deduction would help minimize these costs. Considering the current rates are more compressed than previous rates, if the rate brackets were expanded and rates lowered relative to average rates, the tax system would be more efficient. In think, improving the tax system would require the abolishment of both estate and gift tax.
Bloom, I. M. (2015). Federal taxation of estates, trusts, and gifts fourth edition (Doctoral dissertation, SUNY Buffalo).
Chirelstein, M., & Zelenak, L. (2015). Federal Income Taxation, 13th (Concepts and Insights Series). West Academic.
Crawford, B. J. (2016). Valuation, Values, Norms: Proposals for Estate and Gift Tax Reform. Boston College Law Review, 57.
Joulfaian, D. (2013). The federal estate tax: History, law, and economics. Law and Economics (June 4, 2013).
Kopczuk, W. (2016). US capital gains and estate taxation: a status report and directions for a Reform.
Kopczuk, W. (2012). Taxation of intergenerational transfers and wealth (No. w18584). National Bureau of Economic Research.
McGarry, K. (2013). The Estate Tax and Inter Vivos Transfers over Time. The American Economic Review, 103(3), 478-483.