Overview           

This listing is the first in a series of columns that Mr. Levendis will publish periodically in the online publication, Wealth Strategies Journal.  Each article will be on a subject of his selection taken from Mr. Levendis’ experiences over the past 35 years in representing client families, private businesses, individuals and charitable entities, in the broad area of wealth preservation, or, as in the case of this first piece, each will offer Mr. Levendis’ view on a significant subject within that broad area.  While the pieces will be prompted by Mr. Levendis’ experiences, attempt will be made to focus each article in a manner that will make it useful and productive in the context of contemporary practice.            

This first offering addresses the status of federal tax law applicable to the wealth preservation area, with emphasis on the federal transfer taxes and their future in the context of past, current and projected Congressional activity.
 
FEDERAL TRANSFER TAX LAW AND THE RECENT AND
COMING ELECTIONS

A. Introduction

This article provides the author’s thoughts on the current and projected status of the body of federal tax law that primarily impacts estate planning and related areas, i.e., the federal transfer taxes (the “Transfer Taxes”; IRC Chapters 11, 12, 13), which include the federal gift tax (the “Gift Tax”; IRC Chapter 12), the federal estate tax  (the “Estate Tax”; IRC Chapter 11) and the federal generation-skipping transfer tax (the “GST Tax”; IRC Chapter 13).  Before reaching specific discussion of the future of the Transfer Taxes, this article, in sections B and C below, summarizes basic facts and provides brief commentary respecting the Transfer Taxes and their history.
 
B. The Law

1. Transfer Taxes.  The United States Transfer Taxes, consisting of the Gift Tax, the Estate Tax and the GST Tax, in their current form came into existence with federal legislation enacted in 1976 (the Tax Reform Act of 1976, P.L. 94-455; the “1976 Law”) and 1981 (the Economic Recovery Tax Act of 1981, P.L. 97-34; the “1981 Law”).  These statutes converted an area of federal law, which theretofore had been an incidental (although definable) aspect of tax law, to a separate, involved and comprehensive body of tax law.  The statutes introduced a new, significant integration of the Gift Tax and Estate Tax, together with an altogether new tax, the GST Tax.  For the first time, practitioners in the area of Trusts and Estates, or, in the legal profession, “probate lawyers”, were obliged to become “tax lawyers”. 

Many refinements have been introduced to the Transfer Taxes over the years since 1976, to bring them to their current status.  These changes have involved, among others, a continual and continuing increase in the levels of the basic exemptions from the Transfer Taxes and the basic allowable deferrals of Transfer Taxes.  Those exemptions and deferrals include, under current rules, the Applicable Exclusion Amount for the Gift Tax, the Applicable Exclusion Amount for the Estate Tax, and the GST Tax Exemption, see IRC § 2010, as to the Estate Tax, § 2502, as to the Gift Tax, and § 2631(c), as to the GST Tax; and the Marital Deduction for the Gift Tax and the Estate Tax and the Charitable Deduction for the Gift Tax and the Estate Tax, see IRC §§ 2056 and 2523, as to the Marital Deduction, and §§ 2055 and 2522, as to the Charitable Deduction.  The changes also have included a continual and continuing reduction in the tax rates applicable to the Transfer Taxes.  See IRC § 2001(c)(2), respecting the Estate Tax, § 2502, respecting the Gift Tax, and § 2641, respecting the GST Tax.

Some things, though, have remained constant throughout the current era of changes.  The GST Tax always has been applied at the highest applicable federal  Estate Tax rate; and the Gift and Estate Tax Charitable Deductions always have been a “full” deduction each (with, however, certain significant exceptions involving primarily so-called split-interest charitable gifts), i.e., in general the full amount of any charitable gift is excluded from taxation under the Transfer Taxes.   Further, the current Marital Deduction also is (and has been for many years) a full “deduction”, with the caveat, though, that it does not, of itself, result in the exclusion of property from transfer taxation; rather, it is merely a deferral of the requirement to pay taxes on the property concerned until the spouse who is the recipient of the gift or legacy himself or herself transfers the property, again, by inter vivos gift or testamentary bequest or devise.

2. Income Taxes Related to the Transfer Taxes.  A significant number of federal income tax (the “Income Tax”; IRC Chapter 1) provisions either relate directly to the Transfer Taxes or are complementary of the Transfer Taxes.  Familiar areas of that related body of the Income Tax include, for example, the income taxation of estates and trusts, see IRC Subchapter J of Chapter 1, and the income taxation of tax-exempt organizations, see IRC Subchapter F of Chapter 1. 

C. Transfer Taxes in Context  
          
1. Historical Context. The Transfer Taxes, historically, were invoked by the federal government as a “special” tax designed to fund primarily short-term or emergency needs. See, generally, Federal Taxation of Income, Estates and Gifts,  B.I. Bittker and L. Lokker, Warren, Gorham & Lamont (2nd ed. 1993).  Before thirty years ago, when the 1976 Law came into existence, the principal public policy purpose for the Transfer Taxes (as contrasted with any actual need for the taxes) was the prevention of the accumulation by taxpayer families of so-called “dynastic” wealth.  Id .
 
The Transfer Taxes, however, have been viewed differently in recent years.  Notably, they have been evaluated as a potentially much more significant source of federal revenue.  See, e.g., “The High Cost of Estate Tax Repeal”, by Joel Friedman, Center on Budget and Policy Priorities, June 15, 2006, discussing cost estimates and other figures published by the federal government.  This development has influenced debate on the subject of the Transfer Taxes.

2.  Current Status of the Transfer Taxes.  Currently, the Transfer Taxes, pursuant to the Economic Growth and Tax Relief Reconciliation Act of 2001 (P.L. 107-16), the “Act”, contain the following principal features:

a. Estate Tax. The Estate Tax is imposed on the full value, as of date of death, of the assets of each decedent who is either a citizen or permanent resident of the United States.  IRC § 2001.  The Estate Tax is progressive and has a current maximum marginal rate of 46% (a “descent”, under the Act, from 55% (the highest possible rate prior to the Act, see IRC § 2001(c)(2), which imposed a surtax, on estates large enough to be subjected to it, resulting in an effective 60% marginal rate until an effective 55% flat rate was assessed on the entirety of the property subject to tax) which will end, in 2007, at 45%).  Currently, for the Estate Tax, the Marital Deduction (the “Marital Deduction”) is unlimited; the Charitable Deduction (the “Charitable Deduction”) is unlimited; and the Applicable Exclusion Amount (the “Exclusion Amount”) is $2 million (an increase from the maximum scheduled amount of $1 million under prior law, which, under the Act, will continue to increase to a maximum of $3.5 million in the year 2009).
 
b. Gift Tax.  The Gift Tax also is progressive and is imposed at the same maximum marginal rate as the Estate Tax.  Under the Gift Tax, the Marital Deduction is unlimited; the Charitable Deduction is unlimited; and the Exclusion Amount is $1 million (the same as the maximum amount that had been scheduled under prior law, and an amount that will not increase further under the Act).

NOTE: A significant distinction between the Gift Tax and the Estate Tax applies in the context of their respective exemptions, i.e., the Estate Tax Exclusion Amount currently is twice the amount of the Gift Tax Exclusion Amount and the Estate Tax exemption will continue to rise, under current law, while the Gift Tax exemption is capped, under current rules, at the $1 million amount.  Another significant distinction between the Gift Tax and the Estate Tax is the fact that, while all property included in a decedent’s gross estate, under federal law, is subject to the Estate Tax, property of a taxpayer that is used to pay federal gift taxes during the taxpayer’s lifetime, on gifts made by that taxpayer more than three years prior to the taxpayer’s death, is excluded from both the Gift Tax and Estate Tax.  IRC § 2035.

c. GST Tax.  The GST Tax, as indicated above, is, in historic terms, a new element of the Transfer Taxes. It imposes a complicated set of rules on a transfer of property that, in essence, passes from the transferor  taxpayer (a “first generation taxpayer”) to a younger individual (a “third generation individual”) who is a member (as defined in the Code, see IRC §§ 2613, 2651) of the generation that is two generations below that of the first generation taxpayer.  It is imposed in circumstances in which, historically (i.e., prior to enactment of the GST Tax in 1976), no tax had been imposed, i.e., in circumstances where the intervening generation, or “second generation individuals”, are “skipped” by a property transfer in favor of a third (or more remote) generation individual or individuals.  The GST Tax is a “flat” tax, imposed, as indicated above (see Section B.1), at the maximum marginal Estate Tax rate in effect at the time of the transfer concerned.  Currently, as indicated above, that rate is 46%; it will reduce, under current law (i.e., under the Act), to a low of 45% as of 2007.   §§ 2001, 2641.  The GST Tax Exemption (the “GST Exemption”) matches the Estate Tax Exclusion Amount.