Compared to all the taxes you must worry about during your life, the tax that comes after your death might seem unimportant. And perhaps it is, if you plan to leave everything to charity or your spouse, which can exempt you from the post-mortem tax bite. But if you're hoping to help provide for the future of your children or anyone else, it's important to know about the taxes the government will collect from that gift.
The idea behind the tax is simple: Once you die, all of your assets will be subject to the federal estate tax before they transfer to someone else.
Some states impose their own tax in addition to the federal tax. In practice there are several exemptions, and your assets need to meet a certain minimum to qualify for the tax at all. When the tax is taken before it's distributed to your heirs, it's called an estate tax. When the tax is assessed on the heirs themselves, it's referred to as an inheritance tax. Collectively, these taxes are nicknamed the death tax. You can learn more about them in How Inheritance Tax Works.
The economic implications of such taxes have been controversial. In 2007, while running for president, Hillary Clinton said, "The estate tax has been historically part of our very fundamental belief that we should have a meritocracy, that we do not want a system ... dominated by inherited wealth" [source: AP].
Clearly, then, there is more to this tax than just another way to increase revenue. Many of its supporters believe that it's philosophically and ethically right for governments to impose this tax on the wealthy. Opponents, on the other hand, argue that the tax brings in little revenue while unfairly punishing well-meaning people who want to provide for their families.
Note that Hillary Clinton drew criticism several years later when, in 2014, it was revealed that she and her husband, former President Bill Clinton, had shifted ownership of their home into residence trusts. This action serves as a way to reduce the estate taxes if they plan to leave the home to their daughter, even though they have both politically supported estate taxes [source: Rubin].
To understand the significance of the death tax, we need to be familiar with its fascinating history, which stretches back to ancient times and was even a prominent issue in the most influential legal document in history.
The Ancient Origins of the 'Death Tax'
The death tax has endured so long partly because it's a convenient way to collect revenue. After someone dies, the community must calculate the person's wealth for distribution. This is usually a public transaction, as opposed to private gifts made during life, which are harder to tax [source: Smith]. Thus the government can easily swoop in and take a share.
We know the ancient Egyptians understood this because we have papyrus with depictions of a man being fined for failing to pay the succession tax for his inheritance from his father. Another papyrus depicts a father giving his possessions to his children during his life for a small tax in order to avoid a larger death tax [source: West].
The Romans used the death tax in the first century, when Emperor Caesar Augustus instituted the Vicesina Hereditatium. This translates to "twentieth penny of inheritances" and taxed "successions, legacies and donations" after death [source: Smith]. However, this Roman tax also allowed exemptions for close family and charity to the poor, similar to the modern tax. Pliny the Younger criticized the tax, saying it cruelly took advantage of grieving families [source: Eisenstein]. Yet the tax endured in some form or another for at least a few hundred years [source: West].
The death tax was also prominent in feudal England and France. The most significant medieval reference is found in the Magna Carta. In 1215 feudal England, rebellious barons forced King John to sign this document, which listed many limitations on his powers. In feudal society, the king owned the land and granted its use to his subjects during their lifetimes. Kings and lords would charge a death tax (called relevium, translating to relief) for the kindness of allowing succession.
In practice, the seemingly arbitrary fees fueled bitterness. One of the first clauses of the Magna Carta states that the king agrees to limit the relief heirs must pay upon the death of any "person that holds lands directly of the Crown" [source: British Library].
The History of the 'Death Tax' in the U.S.
During the Scottish Enlightenment, economists and philosophers debated the legitimacy of the death tax. John Locke believed it was proper for government to protect the rights and property of the individual and wrote that it was natural and good for parents to pass wealth on to their children (but not others).
In the 18th century, William Blackstone disagreed, arguing that a person's claim to wealth ended when life ended, and the state should regulate any inheritance. Utilitarian Jeremy Bentham went even further, arguing for strong regulation of inheritance for the sake of the public good. On the other hand, Adam Smith favored the rights of the individual and free market for the ultimate good of society.
The American founders were very familiar with this philosophical struggle. At first, U.S. law aligned with Adam Smith's view of limited regulation, and the tax was used only occasionally. The Stamp Tax of 1797 was used to fund a naval war with France. The tax required people to purchase federal stamps on inventories of the deceased person's effects, on receipts for legacies (tangible property and goods) or shares of the estate, and on probates of will and letters of administration. Estates under $50 were exempt, and larger estates were taxed on a graduated scale. The tax exempted widows, children and grandchildren [source: Luckey].
In 1802, Congress repealed the tax after the need for revenue ended. Congress considered passing the death tax again during the War of 1812, but the war ended before it passed.
A federal death tax next appeared during the Civil War, but with three significant changes. First, the Revenue Act of 1862 taxed the receivers of the inheritance directly, rather than tax the legal instruments used to convey the inheritance by required stamps.
Second, the Internal Revenue Act of 1864 extended the scope of the tax to include real property (i.e., land and buildings) rather than just personal property such as legacies and distributive shares of businesses.
Third, the amendment contained what we would recognize as a gift tax because it taxed the transfer of real property if sold for less than fair market value during life. This last provision was an attempt by Congress to prevent people from dodging the death tax by transferring assets before death. Congress repealed this Civil War-era death tax in 1870.
The 'Death Tax' at the Turn of the 20th Century
The rise of industrialization and the concentration of wealth among successful entrepreneurs led to a rise in Populism, an agrarian political movement that advocated taxing the wealthy at a higher rate. The movement successfully pushed for the passage of the IncomeTax Act of 1894, which included a tax on inheritance and gifts. However, for reasons unrelated to the death tax, the Supreme Court ruled this act unconstitutional.
The Populist movement won a consolation prize a few years later with the passage of the War Revenue Act of 1898 during the Spanish-American War. This was not an inheritance tax (on those who received the inheritance) but an estate tax like what the federal government uses today.
It exempted estates under $10,000 and those left to a spouse. The exact rate of the tax would depend on both the size of the estate and the relationship to the deceased. In 1901, Congress added exemptions for certain charitable gifts. Shortly after the war ended, Congress repealed the tax.
In the years that followed, a growing distaste for inherited wealth gave momentum to the idea of a permanent death tax. Its most powerful proponent was President Theodore Roosevelt, who during a 1906 speech to Congress said:
Despite Roosevelt's strong support, in addition to support from his successors William Taft and Woodrow Wilson, it took a decade, and another wartime revenue demand, to convince Congress to pass the next death tax.
The Evolution of the Modern 'Death Tax'
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.
The 'Death Tax' in the 21st Century
The 1990s were a decade of mostly technical modifications of the estate tax. After the government accumulated a budget surplus in the late '90s, the death tax became a hot political topic in the 2000 presidential election. As soon as President George W. Bush was elected on promises of tax cuts to return this surplus to the American people, the death tax sat squarely on the chopping block.
The Economic Growth and Tax Relief Reconciliation Act of 2001 restructured tax rates in several ways, including reducing the "marriage penalty," increasing the standard personal deduction and raising the Child Tax Credit. In addition, it set a schedule for a gradual reduction of the death tax. The top rate of the estate tax declined from 55 percent to 45 percent by 2009. Meanwhile, the exemption rose from $675,000 to $3.5 million in 2009.
In fact, for one year the estate tax disappeared entirely (but not the gift tax). However, the tax cuts outlined in this act, commonly known as the Bush tax cuts, came with an expiration date: The tax rates were set to return to the pre-Bush rates after 10 years if Congress did not vote to extend them.
The 2008 recession and the election of Barack Obama made the future of the Bush tax cuts uncertain. In 2010, Congress successfully extended the cuts for two years. During this time the top estate tax rate was set at 35 percent. After those two years were up, Congress and the White House negotiated to pass the Taxpayer Relief Act of 2012. This compromise resulted in a permanent exemption of $5 million and a top tax rate of 40 percent.
As of 2013, the estate tax makes up a scant 0.7 percent of total annual federal revenue [source: Center on Budget and Policy Priorities]. This is partly because very few people have estates large enough to exceed the exemption amount. In addition, those who do qualify can afford talented tax lawyers who are able to arrange an estate in such a way that shields wealth from the death tax.
Author's Note: History of the Death Tax
The struggle between individual freedom and public good fascinates me, so I was happy to take on the subject of the death tax throughout history. But studying the subject also got me thinking about parents' obligations to children. On the one hand, many argue that it's only responsible to have children when the parents have saved enough to provide a comfortable life. On the other hand, some say parents do children a disservice when they pay their children's way.
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