Backgrounder: Estate and Gift Taxes -- Myths and Facts

The Federal estate and gift tax is a high-profile public policy issue that, unfortunately, is widely misunderstood due to a lot of ideology muddying the waters. Here are the facts.

The estate and gift tax is a minor slice of the revenue pie, accounting for only 1% of Federal revenues. Furthermore, because of the estate and gift tax “exemption,” as well as various deductions, the estate and gift tax impacts only a tiny percentage of Americans. For example, only 2% of all deaths in the United States in tax year 2001 resulted in estate tax liability; in 2008, only 0.5% of estates are taxed, due to the increasing exemption.

The Federal estate tax is applied when property is transferred at death. After deductions and exemptions, the remaining amount is subject to graduated rates of taxation up to 45% as estate size increases. An unlimited marital deduction is allowed for property transferred to a surviving spouse. Other allowable deductions include charitable contributions and estate administration expenses. In addition, the so-called unified credit exempts the first $2 million of an estate from tax. This is the primary reason why the estate tax impacts only 2% of the estates in the nation. Under current law, the $2 million exemption will increase to $3.5 million in 2009, and the estate tax will be fully repealed in 2010, before it bounces back in 2011.

The major tax cut legislation enacted in 2001 phases out the estate tax over 2002 to 2010. However, due to the Senate’s Byrd Rule, which was designed to prevent the use of expedited budget procedures for passage of legislation that would increase deficits over the long term, the estate tax reverts to pre-2001 law in 2011. This means that—absent a change in tax law—as of January 1, 2011, the estate tax will be reinstated with a pre-2001 exemption level of $1 million.

Estate Tax Filing Requirement

           
The Federal gift tax operates in conjunction with the estate tax to prevent people from shielding their property from estate taxes by making gifts to heirs prior to death. Each year individuals can make gifts of $12,000 to as many individual recipients as they wish, without being subject to the gift tax. However, any amount in excess of this per-person gift limit is applied to a lifetime gift exclusion amount of $1 million. At time of death, the cumulative amount of gift tax exclusion used by the decedent reduces the estate tax exemption. In this way, the gift tax operates in a unified manner with the estate tax.

Myth: The estate tax broadly impacts America’s families.
Fact: Actually, 99.5% of Americans pay no estate tax due to the large exemption amount—currently $2 million. Only the wealthiest 0.5% of Americans pay estate tax. By 2009, when the exemption amount increases to $3.5 million, the coverage of the estate tax will shrink to 0.2%.

Myth: The estate tax poses a serious threat to the survival of small farms and other types of small businesses that lack the liquidity to pay the estate tax.
Fact: According to CRS, “recent estimates suggest that only a tiny fraction of family-owned businesses (less than one-half of 1%) are subject to the estate tax but do not have readily available resources to pay the tax.” With regard to farmers, a CBO study in 2005 estimated that when the estate tax exemption level increases to $3.5 million in 2009, only 65 farm estates nationwide would owe any tax, and only 13 might lack sufficient liquidity to pay the estate tax. In 2005, the New York Times reported that neither the American Farm Bureau Federation nor the National Cattleman’s Beef Association could cite a case of a farm lost to estate taxes.

Myth: Repeal of the estate tax will not increase the Federal Debt.
Fact: Enacting legislation to permanently repeal the estate tax would cost the Treasury $281 billion over FY 2011 to FY 2015—at a time when the U.S. Treasury will already be burdened with rapidly escalating Medicare, Medicaid, Social Security, defense, and homeland security expenditures.

Opponents of repealing the estate tax also point out that (1) it provides a strong incentive for charitable giving (which is deductible from estates), (2) it taxes capital gains that would otherwise be shielded from tax since heirs receive a “stepped-up” basis, and (3) the estate tax furthers the stability of our democracy by mitigating the increasing concentration of wealth in the United States.