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Estate Tax Reform Update

Posted On 6/9/2007

What's happening with estate tax reform? This Alert examines the various estate tax proposals pending in Congress. Many of the proposals under consideration would curtail the effectiveness of many popular estate planning strategies. It concludes that it is unlikely that there will be major estate tax changes this year, but, that changes could be forthcoming next year.
 

The optimism for meaningful estate tax reform in 2009, expressed in Alerts earlier this year, has faded somewhat. According to officials at the Association for Advanced Life Underwriting ("AALU"), permanent estate tax legislation by Congress could be delayed until 2010.

AALU officials state that the most likely scenario is that Congress will extend the 2009 exemption level of $3.5 million per person and a 45% top tax rate into 2010-and then deal with estate reform as part of an omnibus tax package next year. AALU lobbyists cite the President’s and Congress’ focus on health care reform as one of the reasons for the delay in any legislation this year. "Another dynamic consistent with this is the fact that the study of tax reform options requested by President Obama is due in December," according to David Stertzer, AALU CEO. "That would suggest that the big tax issues are likely to emerge in 2010, rather than 2009."

There are currently five estate tax reform bills before Congress:

On January 9, 2009, Congressman Earl Pomeroy (D-ND) introduced H.R. 436, the "Certain Estate Tax Relief Act of 2009" ("CETRA"). CETRA would extend the $3.5 million estate tax exclusion amount and reunify the estate and gift taxes. The estate and gift tax rate would remain at 45%.

On January 14, 2009, Congressmen Mark Kirk (R-IL) and Harry Mitchell (D-AZ) introduced H.R. 498, the Capital Gains and Estate Tax Relief Act of 2009 ("CGETRA"). CGETRA also reunifies the estate and gift tax and increases the estate tax and gift tax applicable exclusion amounts as follows:

Year	Exclusion Amount	Year	Exclusion Amount
2010	$3,750,000	2013	$4,500,000
2011	$4,000,000	2014	$4,750,000
2012	$4,250,000	2015	$5,000,000

Thereafter, the $5 million applicable exclusion amount would be subject to annual cost of living adjustment. CGETRA would set the marginal estate and gift tax rates to 15% for estates under $25 million and 30% for estates of $25 million or greater. In addition, CGETRA provides for the portability of a married couple’s applicable exclusion amount. Thus, to the extent the first deceased spouse did not use his or her full applicable exclusion amount, such amount would be transferred to the surviving spouse. This would greatly simplify estate tax planning and would allow for more post-mortem estate planning by the surviving spouse.

On March 26, 2009 Senate Finance Committee Chair Max Baucus (D-MT) introduced the Taxpayer Certainty and Relief Act of 2009 ("TCRA"). The tax bill includes a $2.3 trillion middle class tax cut package and also creates a freeze on estate tax rates and major estate planning modifications. The bill would make permanent many of the provisions enacted for tax relief during the past decade. Several of the provisions are intended to reduce income taxes for low and middle income taxpayers. The bill would not change the scheduled increase in the top two tax brackets in 2011 to 36% and 39.6%.

TCRA freezes the estate tax exemption amount at $3.5 million per person. The gift and estate tax rate would remain at 45%. The exemption amount would be increased for inflation in $10,000 increments starting in 2011. Farmers and ranchers would benefit from an increase in the special use valuation from $750,000 to $3.5 million. This would permit transfer of very valuable farms and ranches from parents to children who are actually operating the farm or ranch.

TCRA proposes a change that may require modifications to the estate plans of persons with larger estates. The change is called "marital deduction portability." If a surviving spouse passes away with an estate larger than the applicable exemption amount, he or she will be able to use the "aggregate deceased spousal unused exclusion amount." In order to use a portion of the exclusion amount of the first spouse to die, the executor of the estate of the first spouse to die would have to make an election on the first deceased spouse’s estate tax return. If the "Spousal Unused Exclusion" election were made, the surviving spouse would be able to then use the remaining unused estate tax exclusion from the first spouse to die.

Senators Jon Kyl (R-AZ) and Blanche Lincoln (D-AR) introduced the Estate Tax Cut Amendment of 2009 ("ECTA") on April 1. ECTA reunifies the gift and estate tax. It increases the exemption amount to $5 million. It lowers the estate and gift tax rate to 35%.

Almost immediately after its introduction, the Center on Budget and Policy Priorities ("CBPP"), a think tank that was organized in 1981 for the specific purpose of analyzing the impact of federal budget priorities and proposed tax policies on America's poor, lashed out against ECTA. In its report CBPP declared ECTA:

" . . . both fiscally irresponsible - it would pave the way for a significant increase in long-term deficits and debt - and unnecessary to protect small businesses and farms, nearly all of which are already exempt from the tax under the 2009 estate tax rules, which President Obama has proposed to extend. The amendment also would lead to reductions in charitable contributions while benefiting only the wealthiest 0.25 percent of estates."

"The proposal would benefit only a tiny number of estates but carry a large cost. According to new analysis by the Brookings Institution-Urban Institute Tax Policy Center, the estates of only 1 of every 400 people who die - 0.25 percent of such individuals - would benefit at all from the Lincoln-Kyl proposal. Those are the only estates that would owe any estate tax in 2011 if the 2009 estate rules are extended. The estates of the other 99.75 percent of Americans who die already are fully exempt."

"The proposal would discourage charitable giving. Many in Congress have expressed opposition to the President’s proposal to limit itemized deductions for families making over $250,000 because it would cause a modest drop in charitable donations. The Lincoln-Kyl proposal would likely have as large or larger an impact on donations. And unlike the itemized deduction proposal - which would help fund health coverage for the millions of uninsured Americans - its benefit would accrue solely to a small group of very wealthy individuals."

CEO Stertzer of AALU calls the provisions of ECTA "largely symbolic," saying it was offset by another amendment added later, before the entire blueprint, or "concurrent resolution," was passed by the Senate on a party-line vote. The second amendment creates a point of order that would disallow any additional estate tax relief - beyond that which was contained in President Obama’s budget - less an equal monetary amount of tax relief is first provided to individuals earning less than $100,000. That amendment was introduced by Senator Richard Durbin (D-IL) and passed by a vote of 56-43.

Heading in the opposite direction from the bills and amendments discussed above, Congressman Jim McDermott (D-WA) introduced the Sensible Estate Tax Act of 2009 ("SETA"). Introduced on April 22, SETA would lower the current $3.5 million estate tax exemption amount to $2 million. Like the other bills, SETA would reunify the gift and estate tax. It would bring about a return of the graduated estate and gift tax rates: 45% on estates of less than $5 million, 50% on estates from $5 million to $10 million, and 55% for estates over $10 million.

The White House has also proposed curtailing two popular estate tax planning techniques used by the wealthy. The changes to estate tax and gift tax law, which the Obama administration says would raise $24 billion over the next ten years, would be used to help pay for the President’s broad health care overhaul.

The first strategy proposed by the administration is to set a minimum term for a Grantor Retained Annuity Trust ("GRAT") or a Grantor Retained Uni-Trust ("GRUT") at ten years. GRATs and GRUTs are very popular strategies among the wealthy as a means of making lifetime transfers of future appreciation in businesses interests, farmland, and other real estate holdings at a substantially reduced estate or gift tax. The strategy is particularly attractive during times of low interest rates.

A second Obama proposal aims to limit the ability of wealthy families to use family limited partnerships and family limited liability companies to minimize the valuation of assets for estate or gift tax purposes. The proposal would eliminate the discounts available for assets owned by a FLP or FLLC, unless the asset is an ownership interest in a family business. This proposal would impact the estate planning strategies available to individuals whose wealth is primarily comprised of securities investments or real estate.

In 1789, Benjamin Franklin said, "In this world, nothing is certain but death and taxes." While he was certainly correct about death, it appears we may have to wait until 2010 to see what the Obama administration and Congress have in store for us regarding the estate tax.

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