Estate and Gift Taxes - Computation Of Tax

The estate and gift taxes are progressive and unified taxes, meaning that each taxable transfer taking place after 1976 is taken into consideration when computing the tax on subsequent transfers. For example, if A makes a taxable gift of $500,000 in 1990, the marginal tax rate on the gift is 34 percent. If A makes another taxable gift of $200,000 in 1992, the tax is computed on $700,000, the sum of the post-1976 gifts. Because the first $600,000 of transfers during life and at death are tax free, a unified credit of $192,800 is deducted from the tax on A's 1992 gift. If A dies in 1995 leaving an estate worth $2 million, the tax is computed on $2.7 million, the sum of the value of the estate and the lifetime gifts; the value of the unified credit and the taxes actually paid on the 1992 gift are deducted.

Progressivity in the estate and gift tax system ensures that individuals cannot avoid increased tax rates by making a series of small transfers. If the taxes were not progressive, then $1 million parceled out into ten annual gifts of $100,000 would be taxed at the marginal rate of 26 percent for each gift, whereas under the progressive tax system, the gifts are taxed at the marginal rate of 39 percent. Similarly, unification between the transfer tax systems ensures that individuals cannot avoid paying higher estate tax rates at death simply by giving away most of their property interests during life. Thus, in the case of A above, the marginal tax rate on A's estate is 49 percent, computed on $2.7 million of total lifetime and death transfers, rather than 45 percent, computed only on the value of the gross estate.