Federal estate tax deadline looms
Under the terms of EGTRRA, the federal estate tax exemption amount increased from $675,000 in 2001 to $3.5 million in the current year, 2009. As the exemption amount increased, the top federal estate tax rate decreased. In 2010, for one year, there is a repeal. If no further action is taken, the federal estate tax will "sunset" to its original provisions beginning in 2011.
A brief snapshot of the changes to the exemption amount and tax rates appears as follows:
YearExemption AmountTop Tax Rate
2001 -- $675,000 -- 55%
2002 -- $1 million -- 50%
2003 -- $1 million -- 49%
2004 -- $1.5 million -- 48%
2005 -- $1.5 million -- 47%
2006 -- $2 million -- 46%
2007 -- $2 million -- 45%
2008-- $2 million -- 45%
2009 -- $3.5 million -- 45%
2010 -- *Repealed * -- 0% *
2011 -- $1 million -- 55%
Of course, when EGTRRA passed, most tax practitioners believed that Congress would change it, one way or the other. The GOP vowed to make the repeal permanent but found themselves unable to push through any related legislation. When Democrats won both the House of Representatives and the Senate in 2006, they claimed that they would extend the bill, but three years later, they still haven't managed to do so.
In other words, absolutely nothing has happened in nearly 10 years.
Many wonder what the big deal would be if the federal estate tax was allowed to disappear for one year and return in 2011 as planned. Unfortunately, there's quite a bit to worry about.
First, there is the nightmare of basis adjustments. Currently, the Tax Code allows for a "step up" in basis on assets held at death. With no federal estate tax in place, the basis rules for assets become very complicated: the stepped up basis at death rules will be repealed and replaced with modified carryover basis. Estate administrators will be required to track the cost basis of the decedent's assets which eventually pass to beneficiaries, a difficult job at best. In addition to a rigid reporting scheme, the new rules for carry-over basis could mean taxpayers who otherwise might not have been subject to the federal estate tax will be subject to capital gains tax.
The new system would also mean additional tax forms, revamped IRS audit procedures and possibly, new IRS software. These are expensive and complex administrative changes for a system that is currently slated to be in place for just one year. It's perhaps not the best use of taxpayer money to spend more money to administer a new, temporary tax scheme.
Additionally, the year-long gap in the federal estate tax could lead to another problem: extensive litigation. Tax professionals agree that it's practically impossible to craft a foolproof plan for the repeal and resurgence of the federal estate tax. Wills that were written before 2001 may prove to be outdated and may contain provisions that create tax-savings trusts that are not needed or that are insufficient; wills that were written anticipating that the estate tax would be extended may face a similar fate. Beneficiaries are likely to resist many of the protections meant to save them from a tax that may not even exist.
According to the non-partisan think tank, the Center on Budget and Policy Priorities, under the current rules, only the largest 1 in 500 estates pay any tax. In other words, 99.8% of estates are not affected by the federal estate tax at all. If no action is taken by Congress, the federal estate tax rates will increase and personal exemption rates will drop. This means that more taxpayers will be affected, either by the federal estate tax or by the capital gains tax.
It's clear that inaction is not a solution. The House has managed to pass a compromise bill but the Senate will likely not do anything until 2010 -- and then only in the form of a retroactive bill. Temporary repeal, new rules, retroactive bills -- that's not a tax system. It's a mess.