ESTATE AND GIFT TAXES
A combined federal tax on transfers by gift or death.
When property interests are given away dur-
ing life or at death, taxes are imposed on the
transfer. These taxes, known as estate and gift
taxes, apply to the total transfers that an individ-
ual may make over a lifetime.
Estate and gift tax law is primarily statutory.
Although the TREASURY DEPARTMENT issues
regulations governing the interpretation of the
revenue laws, and although state and federal
courts contribute their interpretations of statu-
tory law, the foundation of the transfer taxes
rests in chapters 11 and 12 of the INTERNAL REV-
ENUE CODE. To understand the complex statu-
tory framework requires a basic understanding
of the concepts underlying the estate and gift tax
system. The transfer tax laws apply to all gratu-
itous shifts in property interests. But although
administered similarly, the estate tax and gift tax
have somewhat different goals. The gift tax
reaches the gratuitous ABANDONMENT of own-
ership or control in favor of another person dur-
ing life, whereas the estate tax extends to
transfers that take place at death, or before
death, as substitutes for dispositions at death.
Both taxes are intended to limit the concentra-
tion of familial or dynastic wealth.
Estate and gift taxes became a source of
political debate in the late 1990s, as many mem-
bers of Congress pressed for an end to these
taxes. They argued that such “death taxes” were
unfair and forced small businesses and family
farmers to sell off their assets to pay the estate
taxes. Opponents of repeal noted that even
though the potential tax rate was quite high, at
55 percent, most individuals never paid any estate or gift tax. Under the tax system that had been in place since 1986, every person could
transfer a combined $600,000 worth of prop-
erty during life and at death without paying tax.
This tax-free allowance corresponded to
$192,800 worth of federal tax savings and is
known as the “unified credit against estate tax.”
This unified credit was sufficient to satisfy taxes
on transfers by all but the richest five percent of
U.S. citizens. Defenders of estate and gift taxes
maintained that these taxes were guided by an
important government and social policy: the
prevention of large concentrations of dynastic
wealth. Moreover, they pointed out that estate
tax collections typically constitute less than two
percent of total INTERNAL REVENUE SERVICE
collections.
The debate on this issue culminated in the
Economic Growth and Tax Relief Reconciliation
Act of 2001. The top estate tax rate was reduced
from 55 percent to 50 percent in 2002 (together
with the repeal of the 5 percent surtax on estates
over $10 million), 49 percent in 2003, 48 percent
in 2004, 47 percent in 2005, 46 percent in 2006,
and to 45 percent in years 2007 through 2009.
The credit-level exemption was raised from
$675,000 to $1 million in 2002, $1.5 million in
2004, $2 million in 2006, and $3.5 million in
2009. Most importantly, the estate tax was to be
repealed in 2010. However, the law contains a
“sunset” provision. If Congress does not extend
the law beyond 2010, the new law will end on
December 31, 2010, and the previous estate law
will be in effect again. Since the political land-
scape undoubtedly will have changed, it is
impossible to predict what will happen to the
estate tax.
The gift tax was not repealed, but it was
modified. The new law increases the total gift tax
exemption from $675,000 in 2001 to $1,000,000
in 2002 and thereafter. After 2009, the gift tax is
retained at the top INCOME TAX rate for the
applicable year, which is currently 35 percent.
The retention of the gift tax is meant to discour-
age transfers to lower income beneficiaries to
minimize capital gains taxes.
With few exceptions, the individual making
the transfer is responsible for any transfer tax
owed (whereas, in contrast, the individual
receiving income is responsible for any income
tax owed). Thus, the executor of an estate, as the
estate’s representative, is responsible for paying
any estate tax due, and the donor of a gift is
responsible for paying any gift tax due.
Gifts
The Internal Revenue Code defines a gift as
a “transfer . . . in trust or otherwise, whether the
gift is direct or indirect, and whether the prop-
erty is real or personal, tangible or intangible.”
Generally, a gift is any completed transfer of an
interest in property to the extent that the donor
has not received something of value in return,
with the exception of a transfer that results from
an ordinary business transaction or the dis-
charge of legal obligations, such as the obliga-
tion to support minor children. This definition
of gifts does not require the intent to make a gift.
An individual may make gifts of both present
interests (such as life estates) and future interests
(such as remainders) in property (26 U.S.C.A.
§ 2503(b)).
From a tax standpoint, gifts have two princi-
pal advantages over transfers at death. First, gifts
allow a donor to transfer property while its value
is low, allowing future appreciation in property
value to pass to others free of additional gift or
estate tax. Second, provided that the gift is of a
present interest in property, a donor may trans-
fer up to $11,000 exempt from tax to each donee
every calendar year, which allows the donor to
reduce the size of the estate remaining at death
without any transfer tax consequences.
To constitute a gift, a transfer must satisfy
two basic requirements: It must lack considera-
tion, in whole or in part (that is, the recipient
must give up nothing in return); and the donor
must relinquish all control over the transferred
interest. To constitute a tax-exempt gift, a trans-
fer also must constitute a present interest in
property. (A present interest is something that a
person owns at the present time, whereas a
future interest is something that a person will
come to own in the future, such as the proceeds
of a trust.)
Lack of Consideration A transfer is not a
gift if the transferor receives consideration, or
something of value, in return for it. For exam-
ple, if A sells B a used car worth $5,000 and
receives $5,000 in exchange, the transfer is not a
gift because it is supported by “adequate and full
consideration” (26 U.S.C.A. § 2512(b)). But if A
sells B the same car for only $2,000, the transfer
constitutes a gift of $3,000 because A exchanges
$3,000 worth of car for nothing. Finally, if A
gives B the car without receiving anything in
return, the transfer constitutes a gift of $5,000.
Although consideration may be whole or par-
