What will federal estate tax legislation look like in 2010? It’s anyone’s guess. Yes, legislation on federal estate tax is expected to be enacted within weeks. The Obama Admistration calls estate tax reform “must do” legislation. Nevertheless, to say that uncertainty is as to the precise nature of how the final legislation will shake out is rampant is an understatement.
If our representatives wish that estate tax law not return, in 2011, to the arguably Cro Magnon exemption equivalent limits and brutally high top rates of 2001, it is quickly running out of time. However, legislative proposals seem light years apart
During the Presidential campaign, then Candidate Obama’s platform advocated the freezing of the applicable exclusion amount (meaning property that can pass at death without exposure to federal estate tax) at $3.5 million, and the top estate tax rate, for estates over that amount, at 45%. These policies were, of course, promulgated before it appeared that the recession would seem everlasting with tax revenues to the federal government dropping to correspond with the dismal employment statistics . Citizens and their estate planning advisors may be fretting that the government (profoundly in need of revenues) may be feel required to lower the applicable exclusion amount (increasing the number of Americans having estates subject to the transfer- at -death tax) and to raise the federal estate tax rate itself.
Proposed Congressional bills cover a wide range of outcomes. On April 2, 2009, the Senate by a vote of 51-48 approved an amendment to “deficit-neutral-reserve-fund” legislation. The language of the amendment reads as follows:
“The Chairman of the Budget Committee may revise the allocation of a committee or committees, aggregates, and other appropriate levels and limits for one or more appropriate bills, amendments, joint resolutions, motions or conference reports that would provide for estate tax reform legislation establishing—
1. An estate tax exemption level of $5,000,000 indexed for inflation,
2. A maximum estate tax rate of 35%
3. A reunification of the estate and gift tax credits, and
4. The portability of exemption between spouses, and--
provided such legislation would not increase the deficit for either the period of the total of fiscal years through 2009 through 2014 or 2009 through 2019.”
(Note: As of 2009, the gift tax credit is $345,800 while the estate tax credit is $1,455,800. These credits were historically the same and split only beginning in the 2004 tax year.)
On the House side of the Capitol dome, a leading member of the House Ways and Means Committee introduced “The Sensible Estate Act of 2009,” which, if enacted, would provide for:
1. A $2 million exemption equivalent indexed for inflation after 2010
2. An initial rate of 45% on amounts exceeding $1.5 million on the Tax Table, a rate of 50% over $5 million, and a rate of 55% over $10 million (to be indexed for inflation after 2010)
3. Restoration of the credit for state death taxes and repeal of the deduction for state death taxes,
4. Gift tax exemptions and rates reconformed to the estate tax,
5. Retention of the stepped-up basis at death for appreciated assets,
6. Repeal of the 2011 “sunset” for other transfer tax provisions of EGTRRA, and
7. Portability of the unified credit between spouses.
In August of 2009, the Congressional Budget Office released its analysis of alternative estate tax legislation in light of potential revenue losses. The presumptions in all cases are that any among these alternatives would take effect as of January 1, 2020 and that return to pre-2002 law remains a possibility. Here are the alternatives:
- Alternative #1 assumes a $5 million exemption (property) and a transfer tax rate equal to the capital gains tax rate (15% in 2010 and 20% beyond) as well as the elimination of the deduction for state death taxes. The Budget Office estimates that this would lose $128 billion in revenues over five years and that in 2014 approximately 5,300 estates would be subject to federal estate tax as compared with roughly 58,000 estates under 2009 law.
- Alternative #2 mirrors Alternative # 1, with the exception that estates exceeding $25 million (indexed for inflation) would be taxed at 30%. The Budget Office estimates that this would cause a reduction in revenues of $117 billion over five years, largely due to the 30% rate on larger estates.
- Alternate #3 assumes 2009 law with the (property) exemption remaining at $3.5 million that would be indexed for inflation in future years. The Budget Office estimates that this would result in revenue loss of roughly $65 billion and that in 2014 around 9,400 estates would actually have federal estate tax liability.
- Alternate # 4 assumes that the 2010 estate tax repeal and carry over basis enacted under EGTRRA 2001 would become permanent . Under this arrangement, the estimated revenue loss over four tax years hovers around $163 billion.In 2009, the value of an individual’s estate that is exempt of federal estate tax - the “applicable exclusion amount, stands at $3.5 million. ( A noteworthy increase from $2 million in 2008.) Assets in excess of the applicable exclusion amount are subject to a maximum federal estate tax rate of 45%. Although current law provides for a repeal of the federal estate tax in 2010, it further provides for the reinstatement of the federal estate tax for 2011 and beyond with an applicable exclusion amount of only $1 million and a 55% maximum federal estate tax rate.
If indeed we return to the pre EGTRRA law operating in 2001, the $3.5 million (estate ) tax base that would, for Americans dying in 2009, be entirely sheltered by the $1,455,800 federal estate tax credit, would be subject to a net federal estate tax rate of 45.4 %. With a tax base just under $10 million, the net federal marginal transfer tax rate would be 39.8%. However, due to the 5% surtax under Section 2001 (c ) 2, the ultimate rate would be pushed up to 44.8% at $10 million, then 44% over $10.1 million.
The plot thickens. On October 14, 2009, yet another Bill, this one titled the “Estate Tax Relief Act of 2009), was introduced in the House of Representatives. Its major provisions are:
- In each of the ten tax years beginning with 2010 and continuing through 2019, the estate tax applicable exclusion amount (property) would be raised by $150,000 and the top estate tax transfer rate would decrease by 1 percent. Therefore, in 2019, the exemption would be $5 million and the highest estate tax rate would be 35%.
- The deduction for state death tax would phase out by 10 percent per year disappearing entirely in 2019.
In order to keep their clients appropriately informed and prepared to maximize tax savings under whatever iteration (if any) of estate tax reform legislation is ultimately enacted, professionals engaged in estate planning will need to stay on their toes. Executors may have more stringent reporting requirements. Other bills are gunning for the elimination of family limited partnerships and zeroed out grantor trusts. Clients who may have had meaningful estate tax concerns may no longer be subject to federal estate tax at all. New laws may be phased in or standing legislation may be phased out. Advisors should encourage clients to include clauses in their wills that cover alternative legislative outcomes which may incorporate tax rate surprises. Going forth, estate planning will likely become an interesting ride: seat belts may be required.
Carla Gordon, CFP® MSFS is a freelance financial writer