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History and Overview of the Federal Estate Tax

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The federal estate tax is defined by the Internal Revenue Service as a tax on the right to transfer property at death. The tax is imposed on the taxable estate, which is the total fair market value of the property transferred at death (called the gross estate) minus allowable deductions. Deductions allowed under the Internal Revenue Code include administration expenses, funeral expenses, charitable transfers and property that will be passed on to a surviving spouse.

History of the Estate Tax

Prior to 1916, death taxes were enacted temporarily to raise funds for a specific purpose. For example, the first version of the estate tax was enacted by Congress in 1797 to fund the formation of the American Navy. The Revenue Act of 1862 enacted an inheritance tax and introduced a gift tax for the first time in order to fund the Civil War effort. The War Revenue Act of 1898 implemented an inheritance tax of 15%, which was used to fund the Spanish-American War.

The Revenue Act of 1916 assessed taxes on estates based on their value as of the date of death. An exemption of $50,000 was allowed. Rates ranged from 1% for estates with a net value below $50,000 to 10% for estates over $5,000,000. These rates were increased in 1917 to 2% for estates valued at less than $50,000 and 25% for estates over $10,000,000. The Revenue Act of 1918 cut the rates on estates valued below $1,000,000 and expanded the estate tax base by including life insurance proceeds and the value of the surviving spouse's interest in the estate above $40,000 of the estate's value.

The Revenue Act of 1924 raised the tax rate to 40% on estates over $10,000,000 and added a gift tax. The gift tax was repealed in 1926 and the estate tax rate was lowered to 1% for estates below $50,000 and set at 20% for estates over $10,000,000. Between 1932 and 1942, estate and gift taxes were increased several times and exemption amounts were lowered. Estate tax rates were at their highest rate in 1941 — 77% for estates over $50,000,000.

The Tax Reform Act of 1976 brought sweeping changes to the estate and gift tax laws. The reform included a generation-skipping tax. The three separate taxes became part of a unified system for the first time. Estate and gift taxes were capped at 70% for estates over $5,000,000.

The Economic Recovery Act of 1981 phased in an increase in the unified tax transfer credit from $47,000 to $192,000 and a decrease in the maximum tax rate from 70% to 50%. The limits on estate and gift tax marital deductions were eliminated. The Taxpayer Protection Act of 1997 phased in an increase in the amount excluded from taxes from $600,000 in 1997 to $1,000,000 in 2006.

Current Law

The current estate taxes are nearing the end of the phased changes set forth in the Economic Growth and Tax Relief Reconciliation Act of 2001 ("2001 Act"). The 2001 Act gradually reduced the maximum estate tax rates from 50% in 2002, to the current rate of 45%, where it will remain through 2009. The amounts exempt from estate taxes increased from $1,000,000 in 2002 to $2,000,000 for 2008. This amount increases to $3,500,000 for 2009. The 2001 Act repeals the federal estate tax in 2010. Unless Congress acts to extend the tax relief offered by the 2001 Act, the rates will return to pre-2001 Act levels in 2011.

The history of federal estate taxes indicates that the U.S. government has used estate taxes as a source of revenue during tough economic times and war. With the war in Iraq draining resources and the current economic recession, it seems possible that Congress will not extend the estate tax relief provided in the 2001 Act.  

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