Update of Permanent Estate Tax Reform Proposals
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On June 7, 2001, the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) ushered in the current federal estate and gift tax regime. Over the past seven years, the federal estate tax exemption has risen from its pre-EGTRRA amount of $675,000 to its current 2008 level of $2 million, and the federal gift tax exemption currently sits at $1 million. In addition, the maximum federal estate tax rate has fallen from 55 % to 45 %. In 2009 the estate tax exemption is scheduled to rise to $3.5 million, and in 2010 current law calls for a complete repeal of the federal estate tax. However, because the changes implemented by EGTRRA were not made permanent, in 2011 the federal estate tax is scheduled to return to its old estate tax exemption amount of only $1 million with a maximum federal estate tax rate of 55% unless Congress adopts permanent estate tax reform.
Following EGTRRA’s passage, it was believed that Congress would, at some point, agree upon and enact permanent estate tax reform. Seven years ago, 2010 seemed so far away it was assumed Congress would address these sunset provisions well before the 2010 repeal and 2011 reversion to the $1 million exemption and 55% top rate. However, 2008 is now upon us and Congress has still not passed a permanent estate tax bill.
The past few years have witnessed a flurry of activity attempting to obtain concrete estate tax reform with hundreds of bills related to transfer taxes. Estate tax reform falls largely along party lines in Congress. Most Republicans appear to support permanent repeal of the estate tax while the majority of Democrats feel the tax provides a valuable source of revenue and should be modified, but not completely repealed. Because of the current political situation, a compromise between the parties will most likely be the result if permanent reform is ultimately obtained.
Over the past few years, estate tax reform bills have, on multiple occasions, passed the U.S. House of Representatives, only to be rejected by the Senate. Although they have not become law, these more recent bills provide a sampling of what a compromise bill may look like when estate tax reform ultimately becomes a reality. On June 22, 2006, the House passed an estate tax compromise proposal that contained the following general provisions: a $5 million estate, gift and generation skipping transfer (GST) exemption indexed for inflation with transfer tax rates equal to those of long term capital gains on estates up to $25 million. On July 29, 2006, another attempt at estate tax reform passed the House. That bill would phase in the exemption increase from $3.5 million to $5 million from 2010 to 2015 and also create an estate tax rate schedule starting with the current long term capital gains rate for estates exceeding the exemption amount. In an attempt to pass this second compromise resolution, the bill was coupled with many other popular proposals, including an increase in the minimum wage, an issue of importance to Democrats. Despite attempts at compromise, the Senate cloture vote for both bills failed by just three votes to reach the 60 votes needed for approval.
If compromise is to be reached, indicators point to the following basic positions: 1) complete estate tax repeal is extremely unlikely; 2) Congress will ultimately provide an estate tax exemption of between $3.5 million and $5 million; and 3) federal estate tax rates will be lowered with a rate or range of rates to be negotiated by the parties, mostly likely somewhat below the current top rate of 45%. One proposed plan believed to be the quick fix for the uncertainty of 2010 and 2011 is to freeze estate, GST and gift taxes at their 2009 levels (a $3.5 million exemption for estate and GST taxes, a $1 million exemption for gift taxes and a 45% maximum estate tax rate) thus removing the one year of complete repeal in 2010 and also eliminating the reversion back to pre-EGTRRA exemptions and rates in 2011.
As we approach 2010, other factors such as timing and election cycles will also likely affect the potential for estate tax reform. Some commentators have suggested that the closer we get to 2011, the less “wiggle room” Republicans will have to negotiate. Because reversion back to the $1 million estate tax exemption and 55% top estate tax rate in 2011 is the last thing Republicans appear to want, some prognosticators predict that Republicans may be forced into a less favorable compromise as 2011 approaches. Regardless of party affiliation, the closer we get to 2010, the more haste and immediacy will be part of any estate tax reform, perhaps resulting in a less than preferred resolution for all parties. Also, the 2008 elections will have an effect on potential estate tax reform. First, the results of the 2008 elections will determine the party make-up of the House and Senate. At present, in order to reach the 60 votes needed in the Senate to pass an estate tax reform bill, 11 Democrats are needed to join the 49 Republicans. A change of just a few Senate seats from one party to the other could greatly affect the possibility of reform. Second, the elections of 2008 will provide a new president. Since the passage of EGTRRA, every budget proposal from the current administration has contained language to make permanent the tax cuts that are due to expire in 2011. This upcoming election may or may not result in a presidential administration with estate tax reform as a priority.
All told, we are no closer to having continuity in our estate tax legislation than we were back in 2001. Consequently, it continues to be important for clients to have estate planning documents that take into account the uncertainty ahead. Despite the unlikelihood of permanent estate tax repeal, numerous estate planning tools and techniques remain that enable individuals to pass their estates to their families in a tax efficient manner. The next one to two years should finally bring resolution to the unknown that estate planners and their clients have had to endure over this decade.
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