Well,
2011 is less than four months away, and Congress has not passed
any reforms to the 2011 Federal Estate Tax. As you know from previous
newsletters, in 2001 Congress passed the Economic Growth and Tax
Relief Reconciliation Act of 2001 ("EGTRRA") that gradually raised
the federal estate tax exemption from $675,000 in 2001 to $3.5 million
in 2009 and dropped the estate tax rate from 55% in 2001 to 40%
in 2009. In 2010, EGTRRA abolished the federal estate tax altogether
and replaced the lost tax revenue by eliminating the stepped-up basis
for capital gains on assets transferred upon death. However,
in 2011, the federal estate tax will return with an inflationary
adjusted exemption level of approximately $1 million and a tax rate
of 55%.
Many people on the right of the political spectrum are not happy
with the return of a lower exemption and higher rates and want a
return to 2009 or a continuation of the 2010 rules. A group on the
left are unhappy with what is viewed as the wealthy not paying any
federal estate tax. They want a retroactive estate tax applied back
to anyone with a taxable estate that has died in 2010. Needless
to say, because of these two issues, along with the political antics
of both political parties, there is a high level of indecisiveness
in the estate planning community on where the 2011 Federal Estate
Tax is going.
The uncertainty has slowly creeped into in the general public's awareness to the point that I thought laying out the suggested plans would be a good idea. I will not address the retroactivity aspect for 2010 because it will quickly drift into high level Constitutional law. Moreover, I think retroactivity is unlikely to happen. It is way too late in the calendar year as the first estate tax forms are due to the IRS in a few weeks. Second, there are several billionaires that died this year and their personal representatives would have large war chests to fight any retroactivity through litigation.
There are approximately 40 different bills sitting in either chamber
of Congress that address the federal estate tax in some form or
other. Some of the bills have no shot of passing like H.R. 205 Death
Tax Repeal Act, even though it has 92 co-signers because of financial
reality. Other bills have very few co-signers, or are just slight
derivatives on other bills. I think there are four real proposals
on the table that have the most momentum and support, though, when
dealing with Congress, anything can happen, and it could all change.
The four proposals are: the Obama proposal, the Lincoln/Kyl proposal,
the Harkin/Sanders proposal, and the Do-Nothing proposal.
The basics of the Obama proposal would include:
- Creating a $3.5 million exemption that is not indexed for inflation
- Having a top rate of 45% for both the estate and gift taxes
- Continuing the gift tax and the generation skipping transfer tax
- Repealing the state death tax credit in favor of the estate tax deduction
- Repealing the qualified family-owned business deduction
- Having no portability or unified credit aspects
- Requiring a 10-year period for Grantor Retained Annuity Trusts ("GRATS")
The analysis of this bill is pretty simple. It maintains many of the
same aspects of EGTRAA like the $3.5 million exemption level and tax
rate, but would be particularly nasty in what the government is eliminating
to pay for the program under its PAYGO rules. In this case, the Obama
proposal is eliminating the tax credit an estate receives on its federal
estate tax payment due to payment of state estate taxes and replacing
it with a deduction. A credit is always better than a deduction because
it comes right off the top, while a deduction is based on the tax
rate. The Obama proposal also extends out GRATS to ten years and repeals
the qualified family-owned business deduction.
The basics of the Lincoln/Kyl proposal would include: - Setting the estate tax rate at 35 percent, phasing it in over 10 years
- Having a $3.5 million exemption amount, eventually rising to $5 million in 2020 and indexed for inflation thereafter
- Providing a "stepped up basis" for inherited assets
- Including an alternative election for 2010 that would allow deceased taxpayers to either retain this year's estate tax rate (0%) together with "carry over basis" (as opposed to "stepped up basis") or file under the provisions of the new bill using the new rate (35%) together with "stepped up basis."
From a simple glance, it looks like this bill would follow along the trajectory of EGTRRA by continuing to raise the exemption and lower the tax rate for the federal estate tax until the year 2020. The main issue with the Lincoln/Kyl proposal is that it would generate less revenue than the Obama proposal, and there would be a need to make up the difference in some form under PAYGO rules. Senators Lincoln or Kyl have not addressed that issue to this point. The bill would also provide a quasi-retroactivity to capture some of the lost estate tax due in 2010, but it would be based on the personal representative's option that best suit the estate.
Early this summer it appeared that Senators Lincoln and Kyl had enough other Senators on board that they asked the Senate Finance Committee to amend H.R. 5297 --Small Business Lending Fund Act of 2010 bill, to incorporate the federal estate tax issue into H.R. 5297. However, it never gained much traction. Since then, the Small Business Lending Bill has under gone huge changes, and it is unlikely to include the federal estate tax issue.
The basics of the Harkin/Sanders proposal would include: - Having a progressive tax rate based on estate size structured as:
- For estates between $3.5M and $10M would be taxed at 45%
- For estates between $10M and $50M would be taxed at 50%
- For estates above $50M would be taxed at 55%
- For estates above $500M there would be a 10% surtax on the 55% rate
- Protecting family farmers by allowing them to lower the value of their farmland for estate tax purposes by up to $3 million and indexed for inflation
- Being retroactive to the beginning of 2010
- Closing loopholes including:
- requiring consistent valuation for transfer and income tax purposes
- modifying the rules on valuation discounts
- requiring 10-year minimum term for (GRATS)
The basis of the Harkin/Sanders proposal was the death of George Steinbrenner and other billionaires that could pass their assets, estate tax free, in 2010. It is the most progressive bill given its staggered tax rate based on estate size. I will say it is also the most confiscatory of the approaches. A tax rate of 65% percent on estate above $500 million is pretty harsh. The likely consequence is that someone with $500 million in the bank will change citizenry from the United States to another country where they already have a home to avoid the 65% tax rate.
The Do-Nothing proposal would make no changes, and the 2011 provisions of EGTRRA would come into effect on January 1, 2011. The Do-Nothing proposal would re-introduce the federal exemption rate at approximately $1 million and institute a tax rate of 55% on estates over that amount.
So where do we stand right now? It is all about politics and whether either side is willing to compromise to get a deal done. The conventional wisdom is that Congress will address the issue after the elections; however, I am not so sure. Most estate planning attorneys felt Congress would not let the federal estate tax disappear in 2010, but it did happen. My feeling is that it is very easy, politically, to let the Do-Nothing proposal to occur. Then both parties can use that as a fund raising issue and also point to the other party as the reason for EGTRRA's 2011 bite.
Finally, to answer the question I posed in the title of this article: unequivocally, yes, the federal estate tax is coming back in some form in 2011. With Congress in gridlock right now over the election, the Do Nothing proposal becomes more likely with each passing day. Sadly, as I noted last month, people with small estates will be scooped up in the mess and pay thousands of dollars in taxes they shouldn't if Congress addressed the issue.
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