Likely Estate Tax Law Changes

This year the estate tax exemption has moved to $3,500,000 for U.S. citizens and is scheduled to go to zero for next year, 2010!

The question we've all been debating for years is, "Will the estate tax be allowed to stay at zero, or will it return to 55% in 2011 with only a $1 million exemption?"

Or, reduced to a simpler question, “Is Congress going to intervene to halt the built in evolution of the estate tax law before the rates go to zero?”

In the words of that illustrious politician and the Saturday Night Live comedian, who both used these words so eloquently during the last presidential campaign, “You betcha!”

Congress will NOT let the rates go to zero, NOT with a burgeoning federal budget deficit and a Democratic Congress. Just before Hurricane Katrina, the Republican controlled Congress was about ready to eliminate the estate tax entirely. But, once the hurricane hit, decided it would be too much of a public relations disaster to further feather the nests of those who were already snuggled into heavy piles of down, when so many people in New Orleans and environs had no nests at all.

If that had happened, the estate tax might have died a quiet death, largely because only six tenths of one percent (.6%) of federal tax revenue is derived from the tax. It is one of the most unpopular taxes ever devised, which is interesting, since most of the people who hate it so much will never be subject to it.

The basis for that unpopularity seems to be this proposition, “We were taxed on the money when we earned it. So, why should we be taxed on it again?”

There are lots of theories, which could be offered in response to the foregoing question, such as giving those born without silver spoons in their grasp a closer to equal chance for success in life. Or, the statistics that show how short a time most family fortunes last in generational transitions before they are squandered. Or, the destructive lifestyles that many of those who inherit large sums portray. I was playing golf with a friend, who was a retired bank trust officer, who proclaimed [referring to those with inherited wealth], “They’re all brats!”

But, I’m not trying to make a case for the estate tax, I’m just trying to present some of the arguments on both sides. On the other side, one need only look at Donald Trump and Howard Hughes to see a couple of examples, where men by their own initiative added incredibly to family fortunes, that might have been nil, if they hadn’t had the leg up their family legacies gave them.

Back to the question at hand. The argument that the tax is unfair, because the money has already been taxed is FALSE to a large extent. Thing is, one only pays taxes on capital gains upon the sale or exchange of an asset. No sale; no tax. A vast portion of U.S. wealth (at least before the real estate and stock market crashes of ought-seven) is in assets with unrealized appreciation. To pass them onto another generation without a tax is something I’m sure those with the power to tax could not bear!

So, they’ve already devised elaborate means to tax that unrealized appreciation as capital gains in the absence of an estate tax. Prior to 2010, that property can pass without income taxation, because it gets a step-up in basis in the hands of the beneficiary under federal income tax law.

Be careful what you wish for! Eliminating the estate tax entirely could open the internal revenue code to a set of laws with byzantine regulations to treat a death as a sale or exchange and trigger an income tax. If you think the estate tax has been unpopular, you ain’t seen nothin’ yet. For one thing, efforts to repeal the step up in basis rules have escaped the ability of the most literary and erudite among us to even codify with clarity and ease of interpretation. Yes, there have been attempts, but those on all sides of the proposition have declared them woefully inadequate.

So, what’s most likely to happen? From what I have read and heard, I think the smart money expects the estate tax law to remain in force with a much larger exemption that the $1,000,000, scheduled for 2011. Numbers I hear are anywhere from $3 million to $5 million. It could be indexed for inflation, but that would require too much good sense and potentially put the politicians out of business. I mean, what would Congress do if they didn’t have to come to our rescue every year or so to amend the alternate minimum tax rules, so it doesn’t eat us alive? Where would be the white charger for each of them to ride in on every year to come to our rescue?

Can I guarantee this (permanent estate tax, increased exemption) outcome? Of course not. But, that’s where the smart money is these days.

In the meantime, we msut continue to do our estate planning with what we know, i.e., a one-year hiatus from the tax (not likely to be honored by Congress), followed by a $1 million exemption, ad infinitum thereafter.

Note: I am providing this commentary on current legal developments as a pro bono public service. [In Hawaii, we are encouraged to do lots of this.] It should not be considered legal advice, as that depends on many facts and circumstances and individual situations to which I am not privy. Receipt of this article does not establish an attorney-client relationship and should be viewed as one person’s perspective on prospective developments to which reasonable minds could differ.

N.B., the author hereof is licensed to practice law in California and Hawaii. Individual consultations are not available to those in other states, wherein all federal legal implications must be further evaluated within the context of local law. All investment advice given on an individual basis is incidental to the author’s law practice, which has a firmly established policy that all attorney-client relationships be documented with an initial engagement letter or memorandum. If you do not have a currently active and valid written, mutually signed agreement on file, then you are not a client.

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