President Woodrow Wilson set the stage for a death tax by lowering tariffs on U.S. allies during World War I and building a stronger defense in preparation for war. So, by 1916, when Congress was searching for a new source of revenue, proponents of the death tax seized their opportunity. Thus the Revenue Act of 1916 was passed, and the modern death tax was born.
This law taxed estates, including real and personal property; transfers occurring at death, after death or in the two years before death; and transfers made for inadequate consideration, life insurance and joint property. Estates under $50,000 were exempted, and it included a graduated rate from 1 percent on amounts under $50,000 to 10 percent on amounts over $5 million.
The years that followed brought several changes in rates and revisions to the law, including a gift tax in 1924. This gift tax was declared constitutional but was repealed two years later. With the Great Depression of the 1930s, the government faced decreased revenue from income taxes and the need to fund popular programs to aid the economy. So, Congress turned to increasing the rates of the estate taxes and reintroduced the gift tax.
The outbreak of World War II prompted Congress to increase rates again. Starting in 1941 and for the next 36 years, the top estate tax rate remained at 77 percent.
The most radical change to the original 1916 law came from the Tax Reform Act of 1976. Among other things, this unified the gift and death tax at the same rates. Whereas gift taxes had been lower (making it advantageous to give wealth away during life), this law eliminated that difference.
Another major change was the addition of the Generation Skipping Transfer Tax (GST Tax). The GST Tax ensures that an inheritance is taxed at every generation level. Without the GST Tax, someone could leave inheritance to grandchildren, essentially skipping the middle generation and avoiding those taxes. Or children of the beneficiary could receive interest generated tax-free from assets that ultimately went to the grandchildren of the beneficiary.
Also in this landmark act, Congress reduced the top rate to 70 percent. And because the exemption of $60,000 had remained unchanged during the previous three decades despite growing inflation, Congress increased the exemption from $60,000 to $120,667 [source: Auerbach]. Top rates continued to fall while exemptions continued to rise through the 1980s. Meanwhile, Congress added rules benefiting closely held and family businesses and included an unlimited marital exemption.