The Estate-Gift Tax: Why Scrap It?

By Martin M. Spencer

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When the estate tax was originally enacted early in the twentieth century, it was often avoided through predeath transfers. Persons with the necessary authorization could simply transfer to intended beneficiaries all of the wealth of the individual about to die. To thwart this tactic, statute drafters enacted a coordinated estate-gift tax on testamentary transfers; transfers at death were combined with a tax on inter vivos transfers (gifts made while alive). Now, high-net-worth taxpayers face an estate-gift tax levy on the combined base of all their taxable gifts together with their net worth at death.

The Revenue Act of 2001, however, initiated a phase-out of this estate-gift tax at death. If a taxpayer dies in the year 2004 with a net worth less than $1.5 million and no past taxable gifts, an effective exemption of $1.5 million subtracts from any estate-gift tax base of higher amounts. The 2001 act increases this effective exemption in future years. An unlimited exemption is scheduled in 2010, but in 2011 it reverts to the pretax situation unless a new statute is enacted.


Complicated marriage-related issues often arise in the administration of the estate-gift tax. Under the spousal deduction, the estate-gift tax does not apply if one partner in a married couple dies. The government does not expropriate part of that married net worth, waiting to collect the estate-gift tax when the surviving partner dies. Continuous remarriages to successive younger partners can postpone payment of the estate gift tax indefinitely through successive spousal deductions.

Taxpayers can also avoid the estate-gift tax through a qualified terminable interest property (QTIP) trust. Using a QTIP trust, a surviving spouse becomes a lifetime beneficiary, drawing only income while the principal eventually goes to other intended beneficiaries, such as children by a former marriage.

Transfers to Tax-Exempt Entities

Much of the wealth of this country is owned by entities operated to provide income for some public benefit (e.g. charitable, educational, or religious entities). There is an unlimited exclusion from the estate tax base for all transfers to any of these entities. As a result, high-net-worth individuals that want to keep their wealth under the control of family or friends often transfer it all to a family foundation. Ostensibly, the income (less fees and expenses) is spent to benefit the public. In this context, capital gains, realized or unrealized, are not income but additions to the entity’s principal, adding to the wealth that designated successors will be called upon to manage. Many high-net-worth individuals make testamentary transfers to family foundations and also inter vivos transfers, thereby reducing both income tax while they are alive and estate tax when they die, all of which cuts deeply into tax revenues.

Net Result

Estate-gift tax avoidance techniques are used on a large scale. The results can be seen in tax revenue collection figures, approximately $25 billion per year. Considering the gigantic aggregates of wealth that pass at death, the estate-gift tax collected is small, especially once the related costs of rule making, administration, enforcement, and litigation are tallied. Any reasonable estimate of related costs produces an inescapable conclusion: The estate-gift tax collects next to nothing.

Some commentators say that capitalism tends to develop a hereditary plutocracy owning vast amounts of wealth and that government has to expropriate part of that wealth as it passes to others at and before death. But practical analysis shows that the estate-gift tax is not the answer. It is rife with inequities, problems, and loopholes that are readily available and widely used, making the final financial result little more than zero.

Martin M. Spencer, PhD, CPA, practices accounting in Bayside, N.Y. He is the author of When Property Pays Does the Owner Deserve It?





















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