4 potential scenarios for the future of the estate tax
By Julius Giarmarco
Giarmarco, Mullins & Horton, P.C.
The fate of the federal estate tax likely lies in the results of the next election. Here are the most probable scenarios.
The December 2010 tax compromise between President Obama and Republican lawmakers provided for a $5 million gift and estate tax exemption ($10 million for a married couple). Assets exceeding that amount are taxed at a 35 percent rate. The $5 million exemption is indexed for inflation beginning in 2012 ($5.12 million).
In addition, the act unifies the gift and estate tax exemption so that the $5 million exemption can be used to make lifetime gifts and/or testamentary bequests. The act also provides for portability, a feature that eliminates the need for a married couple to establish a marital-family trust to ensure that their heirs receive the benefit of both spouse’s estate tax exemptions. The Tax Relief Act of 2010 that established the current estate tax rules is set to expire on Jan. 1, 2013.
Pursuant to the Budget Control Act of 2011, the so-called supercommittee had until Nov. 23, 2011 to issue a formal proposal containing at least $1.2 trillion in deficit reduction for the full Congress to consider. Among the rumors circulating as the committee neared decision time was that the gift tax exemption amount would be decreased to $1 million effective Jan. 1, 2012, instead of Jan. 1, 2013. Some even predicted that the decrease would take effect on Nov. 23, 2011. In the end, the Super Committee made no decision.
President Obama’s 2012 budget proposes to bring the estate tax exemption back to 2009 levels — $3.5 million with a maximum 45 percent tax rate. The president also wants to eliminate unification by making the gift and generation-skipping tax exemption $1 million, with a top rate of 45 percent.
In addition, the president proposes to make the portability provision permanent so that married couples may continue to carry over unused exemptions, but the exemption amount that would be preserved would be limited to the estate and gift exemption in effect in 2013 and beyond.
In contrast to the president’s proposal, every Republican candidate for president wants the federal estate tax repealed. The most often cited reasons for repealing the estate tax are that many small businesses and family farms have to be sold to pay estate taxes, and that the estate tax (along with the income tax) stifles saving and investing, thereby undermining job creation and productivity.
Most Democrats counter that reducing or eliminating estate taxes for the richest 1 percent of Americans is bad policy, given the large deficits facing the U.S.
So, the fate of the federal estate tax likely lies in the results of the next election. Here are the most probable scenarios:
Scenario no. 1: Because of continued gridlock and Congress’s reluctance to address entitlements and tax reform in an election year, Congress could allow the new law to sunset (as it is scheduled to do on Dec. 31, 2012). Since this scenario is already in place, it requires no further congressional action. If this happens, then a $1,000,000 estate tax exemption and 55 percent estate tax rate will begin on Jan. 1, 2013.
It’s also possible under this scenario that if the new Congress strikes a deal on the estate tax, the new law will be made retroactive back to Jan. 1, 2013. Support for this scenario recently came from Congressman Jim McDermott of Washington, a senior member of the House Ways and Means Committee.
On Nov.17, 2011, Congressman McDermott introduced the Sensible Estate Tax Act of 2011. The bill would, among other things, roll back the top estate tax rate to 55 percent, with a $1 million exemption ($2 million for married couples) indexed for inflation. The bill would also retain both unification and portability. Scenario no. 2: If neither party has complete control over tax legislation, Congress could extend the 2010 law in 2013 and beyond. This would mean that the estate tax exemption would be indexed for inflation above the $5,120,000 exemption that will go into effect in 2012 and the top rate would remain at 35 percent.
Under this scenario, unification and portability remain intact. If this scenario occurs, then the estate tax will be de facto repealed for more than 99 percent of Americans. According to estimates from the Tax Policy Center, there are only an estimated 3,300 estates in the U.S. that would owe federal estate taxes in 2011 under the current exemption of $5 million.
Scenario no. 3: If the Democrats control tax legislation, Congress could pass some form of an estate tax compromise that will lower the estate tax exemption and increase the estate tax rate to something more in line with the 2009 numbers, as the president has proposed for his 2013 budget.
Scenario no. 4: If the Republicans control tax legislation, Congress could permanently repeal the federal estate tax (and bring back carry-over basis). If a Republican wins the White House, this is a distinct possibility, given that Republicans are in control of the House and have gained significant ground in the Senate (where 60 votes are needed to repeal the estate tax).
Support for repealing the estate tax comes from a recent study commissioned by the American Family Business Foundation and conducted at the Institute for Research on the Economics of Taxation. The study found that repealing the estate tax would increase GDP by 2.26 percent by 2021 and would generate enough revenue over a 10-year period to cover almost a third of the current $1.2 trillion in deficit reduction.
Additional support for repealing the estate tax is that it represents a negligible amount of the government’s revenue. According to the Congressional Research Service, with a $5 million exemption and a top rate of 35 percent, only $11 billion in estate taxes will be raised. That amount only contributes 0.321 percent of the $3.5 trillion needed for the government’s estimated annual budget.
Some observers predict that the Republicans might even be willing to trade higher income tax rates for the repeal of the estate tax.
The bottom line is that it’s impossible to know how and when lawmakers will act (and whether any new law will be permanent or just another extender bill). And that makes it exceedingly difficult for clients (and their advisors) to do any intelligent estate planning.
THIS ARTICLE MAY NOT BE USED FOR PENALTY PROTECTION. THE MATERIAL IS BASED UPON GENERAL TAX RULES AND FOR INFORMATION PURPOSES ONLY. IT IS NOT INTENDED AS LEGAL OR TAX ADVICE AND TAXPAYERS SHOULD CONSULT THEIR OWN LEGAL AND TAX ADVISORS AS TO THEIR SPECIFIC SITUATION.