How should wealth be taxed?
There are three options: an estate and gift tax (like the current US federal system), an inclusion tax, or an accessions tax.
The transfer of wealth through gifts or bequests can be taxed in three ways: under an estate and gift tax (like the current US federal system), under an inclusion tax, or under an accessions tax.
Estate and Gift Levy Taxes
An estate and gift levy taxes the donor or the donor’s estate using separate estate and gift tax rate structures. Apart from transfers to spouses and charities, which are generally exempt from tax, and the small annual exemption from the gift tax, the amount of tax imposed on the transfer does not vary with the income or other characteristics of the transfer recipients.
An inclusion tax requires recipients to treat transferred assets as taxable income. The amount of tax therefore varies with the recipients’ characteristics (e.g., their filing status), the amount of their other income, the amount of their deductions, and other factors that affect income tax liability.
An accessions tax, like an inclusion tax, taxes recipients on the value of transfers received, but under a rate structure different from the income tax rate structure. The amount of tax imposed on the transfer therefore depends only on the amount received by the recipient in the relevant time period.
Under all three approaches, the treatment of the donor’s unrealized gains is an important consideration that affects incentives to transfer and the amount of tax revenue produced. A donor’s unrealized gains could be taxed as part of his or her income. Alternatively, such gains could be taxed when realized by the recipient if a carryover basis is required. On the other hand, if a step-up in basis is allowed for the recipient such gains could never be taxed at all.
An important consideration for an accessions tax is the relevant time period over which transfers are taxed. If transfers are taxed annually with a graduated rate schedule, much less tax would be paid on lifetime transfers received evenly over many years than if the entire amount was received in one year. These differences could be addressed by taking into account the accumulated transfers recipients received over their lifetimes, much like the lifetime accumulation of gifts and integration with the estate tax under the current federal tax.
The taxation of lifetime transfers can also differ under an inclusion tax because of the graduated income tax rate schedule. One way to address these differences would be to allow averaging of inclusions over several years.
Under an estate and gift tax, the number of recipients doesn’t affect the amount of tax paid on transfers. Taxing inheritances under an inclusion tax or an accessions tax may encourage broader transfers of wealth because broader transfers would generally reduce the total amount of tax paid.
Batchelder, Lily L. 2008. “Taxing Privilege More Effectively: Replacing the Estate Tax with an Inheritance Tax.” In Path to Prosperity: Hamilton Project Ideas on Income Security, Education and Taxes. Edited by Jason Furman and Jason Bordoff, 1–28. Washington, DC: Brookings Institution Press.
———. 2009. “What Should Society Expect from Heirs? A Proposal for a Comprehensive Inheritance Tax.” Tax Law Review 63 (1): 1–112.
Joint Committee on Taxation. 2015. “History, Present Law and Analysis of the Federal Wealth Transfer System.” JCX-52-15. Washington, DC: Joint Committee on Taxation.