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Financial Planning > Tax Planning

Senate Bill Proposes to Return Estate Tax to 2009 Levels

By Arthur D. Postal

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Senate Democrats this week introduced tax legislation that would return the estate tax to 2009 levels.

At the same time, an industry tax practitioner said that with the possibility that tax rates might be increased and the current estate tax policies might be significantly changed, families are rethinking their tax planning activities.

Doug Siegler, a partner at Sutherland Asbill & Brennan in Washington and a member of Sutherland’s Tax Practice Group, also said that changes in tax laws and a new tax imposed through the Patient Protection and Affordable Care Act scheduled to go into effect next year will also likely affect the types of insurance products that agents and advisors sell.

Specifically, a 3.8% tax on investment income for individuals earning more than $200,000 and couples earning $250,000 mandated through PPACA and scheduled to go into effect in 2013 will impact sales of annuities, both variable and fixed, and may cause individuals and families to purchase life insurance instead.

The provision, Sec. 1411 of PPACA, would apply the new surtax on net investment income to the lesser of the individual’s net investment income or the excess of his/her gross income over the “threshold amount.”

The threshold amount is $250,000 for married couples filing jointly, $125,000 for a married person filing separately and $200,000 for everyone else.

“So someone with total income below the threshold is not subject to the tax, regardless of the amount of income that is net investment income,” Siegler said. Likewise, someone with very high salary, say $500,000, but no investment income, will also not be subject to the tax.”

He also raised alarm about a provision in the Obama administration’s budget proposal for 2013 that would create “coordination” of certain income and transfer tax rules applicable to grantor trusts.

The proposal would include the assets of these trusts in the gross estate of that grantor for estate tax purposes, make subject to gift tax any distribution from the trust to one or more beneficiaries during the grantor’s life, and also subject to gift tax the remaining trust assets at any time during the grantor’s life if the grantor ceases to be treated as an owner of the trust for income tax purposes.

 Siegler cautioned that provision is unlikely to become law anytime soon, and that writing a regulation to implement would be difficult if ultimately enacted. But he noted that tax practitioners have found that these types of proposals take on a life of their own, get proposed a number of times, and can, ultimately, become law.

As for the new legislation, Siegler said that the bill, S. 3393, would establish a $3.5 million per person exemption, indexed for inflation, and a 45% top tax rate.

The bill would continue to unify estate and gift taxes, and sustain the “portability” contained in current law. This provision eliminates the complex estate planning documentation necessary to ensure that beneficiaries of estate get the benefits of a couple’s exemption.

As amended in late 2010 for 2011 and 2012, the Bush tax cuts establish a $5 million exemption and a maximum 35 percent tax rate. Current law also indexes the estate tax exemption, starting this year, raising it to $5,120,000 for 2012.

However, if the Bush tax cuts are allowed to expire, the estate tax will spring back to 2001 levels, with a $1 million personal exemption and a 55% top tax rate.

The bill would extend a transition rule on the use of gift taxes to purchase life insurance designed to shield the beneficiaries of the estate from having to pay taxes, a so-called “clawback” concern voiced by practitioners.

Siegler says the thinking of most tax practitioners is that once the election is over, the most likely options are that Congress will decide to retain either the current system or to return to the 2009 levels.

“I don’t think we will go back to the $1 million level,” Siegler said. “But there is a substantial possibility that we will go back to the $3.5 million level.”

He also said the current uncertainty is motivating the “wait-and-see-folks” to take action to protect their assets.

“People who are protected from estates taxes under the current exemption/tax levels, and were ‘on the cusp’ now realize they might have a greater liability and could decide to establish an irrevocable trust,” Siegler said.

He said another option is to buy more insurance before the end of the year.

“Families with smaller and medium-sized estates who currently have insurance, and have taken a wait-and-see approach, are now more likely to face paying estate tax with the potential for a lower exemption rate and a higher tax rate.

They may now be taking steps to move the excess to an irrevocable life insurance trust,” he said. “Wealthier folks are now looking at a smaller exemption and a higher tax rate and might acquire more insurance to provide liquidity so that their heirs don’t have to pay their estate tax. There is renewed interest in those things right now.”

The new bill, supported by Democrats, focuses on preventing an increase in taxes on households earning less than $200,000 a year at the beginning of 2013. The bill is scheduled to come to the Senate floor next week. Republicans say they will oppose legislation that would raise taxes on any household.

Republicans, including House Ways Committee chairman Rep. David Camp, R-Mich., contend that many small businesses filing their taxes through individual returns would face a tax hike that could interfere with their plans to hire more employees and otherwise increase investment in their businesses.

The bill, sponsored by Sen. Harry Reid, D-Nev., Senate majority leader, would only extend current marginal income tax rates for individuals earning less than $200,000 a year, and $250,000 for couples. The bill would also raise the highest tax rate from the current 36% to 39%.

Insurance agents and brokers will be among those primarily impacted through a huge increase in estate tax liability if Congress is unable to bridge the ideological divide on taxes and tax cuts first enacted in 2001 are allowed to expire at the end of year.

First, there are huge implications if the impasse, currently labeled the “fiscal cliff,” persists, and there is no action by the end of the year. Charles Symington, senior vice president of government affairs for the Independent Insurance Agents and Brokers of America, said allowing estate tax rates to revert to Clinton-era levels would be “punitive” to agents and brokers, with “a staggeringly negative effect on our membership.”

If the estate tax provisions are allowed to expire, there will be a 60% drop in the exemption and a 20% gross increase in the tax rate. As amended in late 2010 for 2011 and 2012, the Bush tax cuts establish a $5 million exemption and a maximum 35% tax rate.

 “When compared to the changes in rates that will occur, both the percentage of change and the gross percentage increase are dramatically more than virtually every other change,” Katzenstein said.

And then there is the uncertainty. Doug Siegler, a partner at Sutherland Asbill & Brennan in Washington and a member of Sutherland’s Tax Practice Group, said a Democratic proposal introduced this week that has a fair chance of passage by the end of the year, would return estate tax policy to 2009 levels.

The bill, S. 3393, would establish a $3.5 million per person exemption, indexed for inflation, and a 45 percent top rate.

Symington explains that most agencies and brokerages are small businesses, organized as pass-through entities such as S-corporations, partnerships and sole proprietorships. That means they pay taxes at individual rates. In addition, many small business members are family-owned.

Symington said that allowing current estate tax law to expire would mean that in many cases a family business would have to be liquidated in order to pay the government.

“This translates to lost jobs in a time when our economy can least afford it,” Symington said, adding that IIABA is working with Congress to ensure an extension of current tax law is passed before the end of the year.

“It is the IIABA’s hope that this will set the table for a wholesale tax code overhaul next year,” Symington said.

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