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Living on a Budget
by Linda Stern, AARP Bulletin, October 23, 2009
Expected changes in federal estate tax law should have anyone with more than $1 million in assets watching Washington carefully. Unless Congress acts, as many expect, federal estate taxes will expire at the end of this year—and then come back with a vengeance in 2011.
The upcoming gyrations are the legacy of a major tax overhaul enacted by President George W. Bush in 2001. Before that law was passed, the top tax rate on inheritances was 55 percent, and heirs could exclude only $675,000 from taxation. The law gradually lowered the tax rate and increased the exclusion, to 45 percent and $3.5 million in 2009. And in 2010, the law abolishes the estate tax entirely.
But the tax law was designed to “sunset” after 10 years. So in 2011, the estate tax springs back to life, imposing a top rate of 55 percent on all estates over $1 million.
“This is such an illogical result,” says Barry Small, an estate-planning attorney for Philadelphia law firm Duane Morris. “It’s shocking it hasn’t been fixed yet.”
Congress is likely to step in before the end of this year, and perhaps act again before the end of next year, most proponents and opponents of the estate tax agree. The House will soon begin working on an estate tax bill, Majority Leader Steny Hoyer, D-Md., said Friday.
President Obama has asked Congress to keep current law in effect and simply extend the 2009 rules through 2010, in order to give lawmakers time to craft a more permanent estate tax law. “That one-year extension is the most likely scenario,” says Rich Kohan, lead personal finance partner with PricewaterhouseCoopers Private Company Services practice.
But once Congress begins a major revision, estate laws will become targets for numerous amendments and prolonged debate. That’s especially true if legislators agree to the one-year extension and punt the issue into 2010, because the entire House and a third of the Senate will be up for election next year.
Already, dozens of estate tax bills have been introduced in the two chambers. A proposal that would raise the exemption allowance to $5 million and lower the tax rate to 35 percent has good prospects, Kohan says. Others would cut the exemption to $2 million, and still others would index it to inflation. Some proposals would create a progressive range of tax rates, based on the size of the estate. Still others create larger exemptions for spouses and family farms.
The number of people who would be affected by a new law depends on how big Washington decides to make the exemption. According to the Internal Revenue Service, 62,718 estate tax returns reporting a gross estate of $1 million or more were filed in 2004, the latest year for which statistics are available. Only 10,055 of them were for estates over $3.5 million.
Of course, many business groups and wealthy families have been pushing for years to permanently end what they call the “death tax.” But last month a group of 46 prominent opponents, including the National Federation of Independent Business and the U.S. Chamber of Commerce, signaled they could accept an estate tax in the future. They backed a resolution, approved by the Senate in April, to set a 35 percent tax rate on individual estates larger than $5 million.
Meanwhile, families bequeathing assets of at least $1 million can count on one more thing besides death and taxes: paying fees to their estate-planning attorneys. The legal framework created to minimize the tax on bequests is typically complex, involving trusts, life insurance policies, charitable gifts and wills. Tinkering with it when Congress changes estate tax laws can be complicated and expensive.
Kohan of PricewaterhouseCoopers suggests that married couples write their wills so that the surviving spouse can decline part of his or her inheritance, allowing it to pass, in a tax-smart way, to a trust or the relatives who are next in line, based on the estate taxes that are in effect at the time.
That could help families position themselves for three consecutive years in which the estate tax law could fluctuate wildly. “It wouldn’t be out of the question for people to have one will for 2010 and a different one for 2011,” observes attorney Small. So if you might be affected, keep an eye on Congress.
Linda Stern is a freelance journalist who writes about financial issues.
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