Senate Democrats last night signaled that they will hold hostage extension of the current, relatively generous, estate tax provisions to higher taxes on the wealthy.

They did so by removing language from a tax bill slated to hit the Senate floor next week that would restore estate tax policies to the same level as those in 2009.

That would mean that, absent affirmative action, the estate tax will spring back to 2001 levels, with a $1 million personal exemption and a 55% top tax rate effective Jan. 1, 2013.

The bill is not expected to reach the 60-vote threshold necessary to clear the legislation for further action.

Instead, the purpose for bringing it to the floor is to allow both parties to showcase their position on tax issues.

Raising taxes on the wealthy and making estate tax policies less generous cuts two ways for the insurance industry.

First, it would provide greater incentive for more people to buy the tax-advantaged products that are the core of life insurance industry offerings and it would encourage the wealthy to buy more tax-advantaged products than they currently do.

For example, sales of variable annuities dropped precipitously after the Bush tax cuts went into effect in 2002. Ultimately, that forced insurers to provide return guarantees in order to compete in the marketplace. This hurt the industry’s balance sheets when the markets plunged in 2007 and especially 2008, severely impacting earnings and forcing some companies to buy above-market rates to raise more capital in a tight market.

At the same time, most agencies and brokerages are small businesses, organized as pass-through entities such as S-Corporations, Partnerships and Sole Proprietorships.

Thus, less-generous estate tax policies would raise the cost for families to structure their business and ensure that the families could retain the business when the current owner dies.

Charles Symington, senior vice president of government affairs for the Independent Insurance Agents and Brokers of America (IIAB), said allowing estate tax rates to revert to the Clinton-era levels would be “punitive” to agents and brokers, with “a staggeringly negative effect on our membership.”

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

As sent to the floor last night, the bill would only extend current marginal income tax rates for individuals earning less than $200,000 a year, $250,000 for couples. It would also reinstate the personal exemption phaseout and overall limitation on itemized deductions that apply to high-income households.

The bill is sponsored by Sen. Harry Reid, D-Nev., Senate majority leader,

Currently, 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.

It also indexed the estate tax exemption, starting this year, raising it to $5,120,000 for 2012. The 2010 amendments made estate tax policies more generous by unifying the estate and gift taxes.

For example, Andrew Katzenstein, a partner in the Personal Planning Department with Proskauer in Los Angeles, said that if the so-called “Bush-era tax cuts” expire at the end of the year, income tax rates for the highest-earning individuals and families will rise from 36 to 39 percent, an eight percent increase.”

But, by comparison, if the estate tax provisions are allowed to expire, there will be a 60 percent drop in the exemption and a 20 percent gross increase in the tax rate.

Doug Siegler, a partner at Sutherland Asbill & Brennan in Washington and a member of Sutherland’s Tax Practice Group, acknowledged that the decision to remove the estate tax provisions from S. 3393 appeared to be part of a new Democratic Party strategy to play hardball on tax issues.

“Although no one can predict how the looming expiration of the so-called ‘Bush-era tax cuts’ will ultimately play out, the withdrawal by Reid of the estate and gift provisions from his middle class tax bill would seem to indicate that there will be a separate fight on the estate and gift tax,” Siegler said.

He explained that a number of Democrats felt “stung” by the concession in 2010 that allowed an increase in the estate and gift exemptions to $5 million and a drop in the top tax rate of 35%, “and they may not be willing to make the same concession on these issues this time around.”

The bill as scheduled for floor action would also establish the top rates for dividends and capital gains at 20 percent for 2013.

The bill would also extend the American Opportunity tax credit, the child tax credit, and the earned income tax credit for another year, as well as the Section 179 expensing provisions for businesses. It also would provide another one-year “patch” covering 2012 from the alternative minimum tax.