The loss of income tax revenue would be the product of income tax saving strategies that would become viable in the wake of gift tax elimination. For example, without a gift tax, the use of a “straw taxpayer” would likely become a prevalent income tax planning strategy. One could freely transfer appreciated or income-producing assets from a taxpayer in a higher bracket to a taxpayer in a lower bracket without imposition of gift tax. This strategy would enable the higher bracket taxpayer to accumulate income or capital gains subject to the lower bracket taxpayer’s lower marginal rates. Of course, the step-transaction doctrine could apply in some cases, but proper tax planning and timing would make it difficult for the Internal Revenue Service to detect such a strategy and succeed in imposing the step-transaction doctrine.
Further, a taxpayer could gift appreciated assets to a non-resident alien, who could then sell and re-gift the proceeds back to the taxpayer. The gains from such a transaction wouldn’t be subject to any income tax, as non-resident aliens who sell appreciated assets that have no U.S. nexus don’t recognize income taxable in the United States.
Absent a gift tax, taxpayers could gift assets to their elderly parents or other relatives to obtain basis step-up on death.
Elimination of the estate tax would also reduce income tax revenues, assuming basis step-up is retained. As taxpayers make lifetime transfers of wealth to avoid estate tax (whether using gift exemptions, sales, grantor retained annuity trusts and the like), the transferred assets don’t obtain a step-up at the donor’s death. The reduction of estate tax revenue from lifetime wealth transfers is partially offset by the loss of step-up, but without an estate tax, taxpayers would retain significantly more assets until death and receive a step-up. And, the taxpayers making wealth transfers are generally the ones with the largest unrealized gains.
Source: Tax Law Update: April 2017
