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Financial Planning > Tax Planning > Tax Reform

Estate Ta Future Is Murky

By Thomas J. Fridrich

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The future of estate taxes remains unclear. It seems as if this has been the case since Congress implemented the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) and temporarily repealed the estate tax for one year in 2010.

Proponents of estate tax repeal and estate tax reform have squared off in the media to garner support for their positions. Both sides offer compelling reasons for their views and, in fact, the justifications for both sides make enough sense that it is hard to say either side is wrong. This article reviews the issues and possible outcomes.

Sen. Jon Kyl, R-Ariz., leads the pro-repeal coalition. He has been an ardent supporter throughout the estate tax battle.

When the Republicans increased their majority lead in the Senate, it was thought there would be enough votes to support full repeal. However, some repeal supporters have had second thoughts due to high budget deficits and concerns over eliminating the stepped-up basis rules. In fact, when the estate tax bill came to vote in September, there were many who believed there was not enough support for full repeal to overcome a Democratic filibuster.

Before deciding to postpone the vote on estate tax repeal due to the Hurricane Katrina disaster, Sen. Kyl was preparing an amendment to the estate tax repeal legislation. The amendment called for increasing the estate tax exemption to an equivalent of about $5 million and lowering the estate tax rate to about 15% beginning in 2010. The proposal also maintained the stepped-up basis tax regime, provided a cost of living adjustment to the exclusion equivalent after 2010, and reduced the gift tax after 2009 to 15%. These amendments would have created an interesting vote.

Sen. Max Baucus, D-Mont., leads the estate tax reform supporters and seeks estate tax reform with a $2 million to $4 million graduated exemption and a graduated tax rate between 30% and 40%.

Repeal supporters argue that the tax is unconstitutional as a double tax on assets previously taxed. Additionally, they argue that the tax destroys family businesses and farms because of its high marginal rates. The highest tax rate for 2005 is 47%.

Moreover, some argue that the tax is wasteful because it takes resources away from investment and growth opportunities and shifts it into planning activities solely designed to decrease or eliminate estate taxes.

Estate tax reform supporters argue, to the contrary, that the tax is beneficial to the country. First, they say the tax provides billions of dollars of revenue that are necessary to support important social programs. Because the tax only applies to the wealthy, any estate tax relief only benefits a very small percentage. Reform supporters argue that an applicable exclusion amount of $2.5 million would eliminate any estate tax burden for 99.8% of Americans.

Additionally, reformers say the tax promotes charitable giving as a means of reducing an estate’s exposure to the tax. Finally, they say estate tax repeal replaces the stepped-up basis tax rules with new carry-over basis rules that would be extremely difficult to calculate and monitor.

On the face, each side provides compelling reasons for the positions stated. This may be the reason why it is likely that estate taxes will stick around.

It may also be the reason why the discussions on compromise raise the exemption and decrease the rate, rather than one or the other. Raising the exemption should help alleviate the impact on small businesses and family farms. Also, a lower tax rate would significantly reduce the tax, thereby making it less offensive.

These changes would keep revenue flowing to the federal government and still provide an incentive to give to charity. Reform along these lines reduces revenue by half, but it is an easier sell than complete elimination. This assumes that the repeal vote ever comes to the table this year. It may not even get the chance with Supreme Court Justices to appoint and Hurricanes Katrina and Rita taking priority.

If estate tax repeal is pushed into next year, there should be enough fiscal concern and room for compromise to suggest that complete repeal may be difficult to sell in the Senate. The history of the estate tax may also convince repeal supporters to agree to sustainable reform that is indexed to inflation.

While a compromise on estate taxes seems reasonable, it is still uncertain what the exact compromise will be or when it will come. One would hope that the country will not have to wait until Dec. 31, 2010, before Congress provides some certainty for those trying to plan estates. It certainly has been an interesting issue to follow the past six months. But as with most issues that drag on, interest will turn to annoyance if definitive action is not taken.

Thomas J. Fridrich, J.D., ChFC, CLTC, is an advanced markets specialist at Mutual of Omaha Insurance Company, Omaha, Neb. His e-mail address is [email protected].

Before Hurricane Katrina, Sen. Jon Kyl, R-Ariz., was preparing an amendment to estate tax repeal legislation that called for increasing the estate tax exemption to an equivalent of about $5 million and lowering the estate tax rate to about 15% beginning in 2010. But a vote on estate tax legislation is now on hold in the Senate.

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