07 Dec Why is my money taxed twice?

Q. Why are some monies taxed twice, and isn’t it double taxation? Such as potential estate tax, inheritance tax, gifting an appreciated stock taxable to the recipient? If someone pays tax when they earn the income, why does it have to be taxed again?
— Taxed and taxed again

A. You’re correct that in many cases, we can be taxed several times on the same money.

To look at how this all came about, we need a lesson in the history of taxes. Here goes.

In the United States, we have a tax on income, a tax when we spend our income and another tax on the right to give our property away.

The first one is called the “federal income tax, the next are various “federal excise taxes” and the third is the “unified gift and estate tax.”

When our nation was first born, the federal government financed its activities by taxing goods imported into the country, said Bernie Kiely, a certified financial planner and certified public accountant with Kiely Capital Management in Morristown. This tax is called a “tariff,” and you could find tariffs on items such as whiskey and glass windows.

“When we entered the Civil War, the federal government needed more revenue to finance the war effort and so it started the first income tax through the Revenue Act of 1861,” Kiely said. “This Act was repealed in 1872.”

Congress proposed the Sixteenth Amendment which was ratified in 1913. This Amendment states: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration.”

Kiely said Congress enacted the Revenue Act of 1913, levying a 1 percent tax on net personal incomes above $3,000, with a 6 percent surtax on incomes above $500,000.

By 1918, the top rate of the income tax was increased to 77 percent on income over $1 million, equivalent to $15.3 million in today’s dollars. This tax increase was to finance World War I, Kiely said.

He said the top marginal tax rate was reduced to 58 percent in 1922, to 25 percent in 1925 and finally to 24 percent in 1929.

“In 1932 the top marginal tax rate was increased to 63 percent during the Great Depression and steadily increased, reaching 94 percent — on all income over $200,000, equivalent of $2.5 million in today’s dollars — in 1945,” Kiely said. “During World War II, Congress introduced payroll withholding and quarterly tax payments.”

Then to federal excise taxes.

Kiely said excise taxes are taxes paid when purchases are made on a specific good, such as gasoline.

“Excise taxes are often included in the price of the product,” he said. “There are also excise taxes on activities, such as using tanning salons, wagering or on highway usage by trucks.”

Then, taxes on your money when you die.

In the 1880s and 1890s, Kiely said, many states passed inheritance taxes, which taxed the donees — the receiver of the inheritance — on the receipt of their inheritance.

“While many objected to the application of an inheritance tax, some including Andrew Carnegie and John D. Rockefeller supported increases in the taxation of inheritance,” Kiely said. “At the beginning of the 20th century, President Theodore Roosevelt advocated the application of a progressive inheritance tax on the federal level.”

So in 1916, Congress adopted the present federal estate tax, which instead of taxing the wealth that a donee inherited as occurred in the state inheritance taxes, it taxed the wealth of a donor’s estate upon transfer. Later, Kiely said, Congress passed the Revenue Act of 1924, which imposed the gift tax, a tax on gifts given by the donor.

In 1948 Congress allowed marital deductions for the estate and the gift tax. In 1981, Congress expanded this deduction to an unlimited amount for gifts between spouses, Kiely said.

“Today, the estate tax is a tax imposed on the transfer of the `taxable estate’ of a deceased person, whether such property is transferred via a will or according to the state laws of intestacy,” Kiely said. “The estate tax is one part of the ‘Unified Gift and Estate Tax’ system in the United States.”

The other part of the system, the gift tax, imposes a tax on transfers of property during a person’s life, Kiely said. The gift tax prevents avoidance of the estate tax should a person want to give away his/her estate just before dying.

In addition to the federal government, many states also impose an estate tax, with the state version called either an estate tax or an inheritance tax.

“Since the 1990s, the term `death tax’ has been widely used by those who want to eliminate the estate tax, because the terminology used in discussing a political issue affects popular opinion, Kiely said.

If an asset is left to a spouse or a charitable organization, the tax usually does not apply.

Instead, the tax is imposed on other transfers of property made as an incident of the death of the owner, such as a transfer of property from an intestate estate or trust, or the payment of certain life insurance benefits or financial account sums to beneficiaries, Kiely said.

In 2016, the federal estate tax exemption is $5.45 million, and twice that for a couple.

“This means that most people aren’t subjected to the federal estate or gift tax,” Kiely said.

But in New Jersey, the estate tax exemption has been only $675,000, so many in the Garden State have been subject to the state estate tax.

But now that’s changing, and New Jersey is on the way to eliminating the estate tax. The inheritance tax still stands — for now.

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This post was first published in December 2016.