Future of the Estate Tax

Kegler Brown Estate Planning + Probate Newsletter

We all know the old saying that the only things in life that are certain are death and taxes. But in reality, there is still great uncertainty about the future of the federal estate (or death) tax. As December begins, Congress has a lot on its plate: healthcare reform, appropriations bills, wars in Iraq and Afghanistan, and, of course, the economy. As a result, many of us in the estate planning world are left to wonder what lies ahead for the estate tax.

The federal estate tax is currently set to expire for one year on January 1, 2010, before returning to pre-2001 levels on January 1, 2011. The only way to (sort of) understand this seemingly senseless law is to consider that when George W. Bush became president in 2001, a full repeal of the estate tax was very much a part of his agenda. Early in his administration, he was just a few votes short of a full repeal of the estate tax. In order to buy time, Congress and the president settled on the current estate tax law, which features increasing estate tax exemption amounts (from $675,000 in 2001 to $3.5 million today, meaning that the first $3.5 million is totally exempt from estate taxes) and decreasing maximum rates (from 60% in 2001 to 45% today) until 2010, when the estate tax would be totally repealed for a year before the law "sunsets" on January 1, 2011. Then, the old law comes back into effect, with its much less favorable $1 million exemption and top tax rate of 60%. Why? Because everyone thought that sometime—long before 2010 rolled around—Congress would agree upon a permanent solution, with the Republicans still pushing for a total repeal of the estate tax.

However, no one was able to foresee the many twists and turns that awaited us, starting with the terrorist attacks of September 11. Estate tax reform quickly became a secondary issue in Washington, and President Bush needed to deploy his waning political capital elsewhere. With President Obama's inauguration in January and the election of Democratic majorities in both houses of Congress, any remaining hopes for a full repeal of the estate tax vanished.

But, now that it's December and less than 30 days remain until the estate tax is slated to expire at month's end, is there any chance that Congress might let the one-year estate tax repeal for 2010 go unfixed? While the political tumult in Washington on healthcare and the economy makes it difficult to believe that Congress can solve all of these massive problems in so little time, the House of Representatives has already approved a bill that would make the 2009 estate tax law permanent, including its $3.5 million exemption amount and its 45% maximum rate.

While the House Bill is uncharacteristically simple and is consistent with President Obama's previously-stated preference to make the 2009 estate tax parameters permanent, the bill still needs to go to the Senate, where senators from both parties are demanding additional changes in the law. Democrats are pushing for restrictions on the ability to discount assets transferred to a family limited partnership and for tougher valuation rules for "non-business" assets transferred to family members. These changes would increase the taxable estates of certain taxpayers and foreclose several popular—and powerful—planning opportunities. Furthermore, the administration has indicated a desire to require minimum durations for Grantor Retained Annuity Trusts (GRATs), which would significantly weaken these potentially potent estate planning tools. Meanwhile, Republicans continue to hold out hope for a higher estate tax exemption amount (perhaps in the $5 million range) and lower maximum rates of around 35%.

But the House Bill is not the only piece of legislation floating around Congress dealing with the estate tax, though it is the only piece of legislation that has been passed by either house of Congress to date. Other bills proposing permanent estate tax solutions have previously been introduced in the House and Senate. Some of these bills retain the 2009 levels, but others propose a reduction in the exemption amount (ranging from $1 to $2 million) and propose increases in the maximum rate, up to 55%.

While no one knows for sure what may happen at this point, it's almost a certainty that the estate tax will not go away in 2010 and the current $3.5 million exemption and 45% maximum rate will continue at least into 2010. If Congress can't agree to make the 2009 estate tax features permanent, they will almost surely agree to at least extend the 2009 rules into 2010 to prevent the estate tax from lapsing for 2010 while they work out a permanent solution. The IRS is apparently confident that this will happen because it just recently hired a number of estate tax examiners and attorneys. In addition, the uproar over the national deficit and President Obama's promise to hold the line on taxes for families making less than $250,000 makes it almost entirely inconceivable that Congress will allow this potential source of revenue to evaporate, even for just a year.

Assuming Congress can only agree upon a one-year patch for the estate tax rather than a permanent solution during these final days of 2009, the focus must quickly turn to a permanent solution. If Congress does not take any action by January 1, 2011, the estate tax will then revert to its 2001 levels, including a $1 million exemption and 60% maximum rate.

Although it's not clear exactly what may be changing in the next year or so, it's likely that the estate tax will be changing soon. And, given the need for additional revenue for the federal government, it's not likely that the future will bring any relief in estate taxes. Accordingly, this year end may be a critical opportunity to take advantage of certain wealth planning opportunities for the following reasons, among others:

  • Upcoming changes to the estate tax, including possible changes in the availability of discounting strategies and short-term GRATs.
  • Historically low interest rates that make certain estate planning strategies even more potent.
  • Recent changes to the income tax laws allowing for conversions of traditional IRAs to Roth IRAs.
  • The opportunity to transfer assets at today's depressed values, so that future appreciation goes to the next generation rather than being subject to estate and gift taxes later.

There are no one-size-fits-all strategies in wealth transfer planning, and obviously no one can accurately predict what the future holds. However, now may be a good time to review your current plan with one of our attorneys and determine whether the end of 2009 offers any unique opportunities to maximize your wealth transfer goals.