Introduction to Gift, Estate & Generation-Skipping Transfer Taxes

Terms:

I.R.C.:
Most tax-related statutes appear in Title 26 of the United States Code, more commonly known as the Internal Revenue Code of 1986 (“I.R.C.”).

Estate tax:
An excise tax levied on the privilege of transferring property at death and usually measured by the size of the estate.

Inheritance tax:
An excise tax levied on the privilege of receiving property from the decedent and usually measured by the amount of property received by each beneficiary.

Excise tax:
A tax imposed on an event or transaction, e.g., a gift or transfer of property at death.

Direct tax:
A tax imposed on a person or on property itself whether or not it has been transferred or otherwise subject to a transaction.

Although individuals have a right to own private property and transfer it after death, this transfer might also be subject to taxation. Death transfer taxes sometimes take the form of an estate tax, which is an excise tax levied on the privilege of transferring property at death and usually is measured by the size of the estate. Another form is an inheritance tax, which is an excise tax levied on the privilege of receiving property from the decedent and usually is measured by the amount received by the beneficiary. The federal government has enacted an estate tax.

In 1916 a Federal Estate Tax was enacted. The constitutionality of this tax was upheld in New York Trust Co. v. Eisner, 256 U.S. 345 (1921), since it was considered an indirect tax, which did not require apportionment among the states. (Ordinarily, under the U.S. Constitution, all direct taxes must be apportioned among the states according to their populations.)

Lifetime gifts were once thought of as a technique to avoid a transfer tax at death. However, the Federal Gift Tax was enacted in 1924 (repealed in 1926, but reinstated in 1932), as a way to counter this trend. A gift tax is imposed on gifts made during one’s lifetime, if they exceed a certain amount. The rate is progressive and cumulative over a donor’s lifetime. When tested, the gift tax was also held to be Constitutional despite arguments based on the apportionment clause, the uniformity and the due process requirements. See Bromley v. McCaughn, 280 U.S. 124 (1929).

Another device that was sometimes used to get around the system of transfer taxes was the creation of generation-skipping trusts. These trusts were structured to eliminate transfer tax liability for succeeding generations by giving gifts straight to one’s grandchildren. This “skipping” of the middle generation saved the transfer taxes that would have been due had the property been given to the middle generation person and then been given from the middle generation person to the grandchild. As part of the restructuring of the estate and gift taxes (creating a unified system), the Tax Reform Act of 1976 created an entirely new tax (generation-skipping transfer or “GST” tax) on these trusts to prevent tax avoidance in this manner. This was done by taxing the entire gift to the grandchild as though it had passed through the estate of the skipped generation. In other words, generation skipping transfers were taxed as if both transfers (to the middle generation person and from the middle generation person to the grandchild) were made. Like many other taxes, the GST tax was completely revised as part of the Tax Reform Act of 1986, in order to eliminate some loopholes that had been created after the 1976 Act.

Transfer taxes do not generate as much revenue for the federal coffers as other types of taxation, such as income and employment taxes. Nevertheless, these systems of taxation free up wealth by discouraging the leaving or gifting of huge sums of money from generation to generation.