I get asked all the time "Why do I have to plan for the "DEATH TAX"... "Are we ever going to see the Estate Tax eliminated in our lifetime? Why do we keep having to deal with the "DEATH TAX?"
My answer is usually the same: "I don't know", or "I doubt it" and "we have to plan for the worst". It is a very good question though. Are we going to see the dreaded "Death Tax" go away in the forseeable future?
A breif history and explanation of the modern estate tax is in order:
The modern U.S. estate tax was enacted on September 8, 1916 under section 201 of the Revenue Act of 1916. Section 201 used the term "estate tax". Opponents of the estate tax began calling it the "death tax" in the 1940s.
Over the years, there have been many modifications of the estate tax, but it has generally targeted "large" estates. The estate tax has gotten more attention in the previous decade since Congress has discussed "repeal" of the estate tax. President George W. Bush and the Republican Congress tried unsuccessfully to eliminate the estate tax and was only able to "phase out" the estate tax and obtain a one-year 100% exemption in 2010. Congress has been unable to extend this exemption and make the 100% exemption permanent. These changes are decribed as follows:
Since 2002, the top rate has decreased from 50%, and the exemption amount has increased from $1 million. In 2009 the rate was 45% and the exemption amount was $3.5 million. On January 1, 2010 a "one year repeal" of the tax was effectuated by a temporary, one-year-only rate of 0%. On January 1, 2011 the estate tax is scheduled to a top rate of 35% and the exemption amount is scheduled to be $5.0 million, or $10 million for married couples. (law passed in December 2010). In 2013, the law "sunsets" and the exemption amount will be decreased to 1.0 million dollars. Unless Congress does not act, the ememption amount will remain at 1.0 million dollars.
In most circumstances, recipients of property who obtain it by inheritance do not inherit the tax basis of the decedent's property. They get the tax basis of the property at the value at the date of death. We call this a step up in basis. This is a significant tax shelter because many many decedents who have owned real property, stocks or other appreciable property for a significant period have a low basis in that property. Elimination of the estate tax would cause an elimination of this tax shelter to all estates and would therefore cause a tax burden on anyone who inherits property with a low tax basis..not just large estates. This would cause an income tax problem for almost everyone because practically everyone will inherit property at one time or another and sell that inherited property. This will not just effect the "rich".
So..we come to the point of whether we will really see an elimination of the estate tax. There is no question that Congress and President Obama is deeply divided on this issue. While President Obama and Congress have agreed in the past to extend "tax cuts" that include a high exemption amount for estates, there is no gaurantee that this will happen this year even if the President is re-elected. Mitt Romney and other Republican candidates for President have stated in their campaigns that they support elimination of the estate tax, but they would probably face a Democratic Senate that is divided on the issue. There are bi-partisan proposals for a complete tax overhaul that could see an elimination of the estate tax. Republican proposals for tax reform would seek an elimination of the estate tax. However, the current political environment renders the future of esate tax elimination hazy at best.
Additionally, there are unintended consequences in eliminating the estate tax without also looking at comprehensive tax reform. Conservatives believe that taxing the deceased is philosophically wrong because taxpayers have already paid taxes on the income that has created that wealth. However, the wealthy also make economic decisions to avoid paying estate taxes..such as creating charitable foundations and donating substantial sums to charities, since these activities reduce the size of the taxable estate. Others contend that significant wealth and capital is tied up and small family businesses and farms must be liquidated or leveraged because of the cost of paying estate taxes...especially when we see the tax exemption for estates at such relatively low levels. Given the state of the economy, serious policy questions will be raised as to how the estate tax effects our economy.
The estate tax faces an uncertain future. Some people think it is here to stay. Others believe it is about to go the way of the dinosaur. I tend to think that it is like the alligator. Its a reptile that may survive extinction but it will have less and less impact and only bite the people who get too close.