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Have Estate Taxes Really Been Repealed?

Recently, a great number of our clients have been joking about why 2010 would be a good year to die. It is their understanding that federal estate taxes have been repealed for persons dying in 2010. But is that really true?

First, a little background.

In 1981, the Unified Credit allowed taxpayers to shelter $175,000 from federal estate taxes upon their death. Congress raised the exemption in 1981 to $600,000 to be phased in over a number of years, from $225,000 to $275,000 to $300,000 to $400,000 to $500,000 and ultimately to $600,000. Not until 1997 did Congress revisit those provisions of the law, noting that $600,000 in 1981 was a lot more money than $600,000 in 1997. Once again, Congress voted to increase the Unified Credit amount from $600,000 to $1 million over the succeeding ten years, from $625,000 to $650,000 to $675,000, and gradually working it’s way towards a million dollars for persons dying in 2007 and thereafter.

In 2000, Americans elected President Bush, who promised among other things, to repeal the death tax. The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) passed by Congress and the Senate in 2001 and signed by President Bush in 2001 provided for, among other things, lower income tax rates, lower capital gains tax rates and a phase out of the federal estate tax over the ten years beginning in 2001 and concluding in 2010. The estate tax exemption’s Unified Credit amount increased to $1 million dollars in 2002, $1.5 million in 2004, $2 million in 2006, $3.5 million in 2009, and if you are "lucky enough" to die in 2010, there are no federal estate taxes.

For over fifty (50) years, Section 1014 of the Internal Revenue Code has provided individuals who inherit property a step-up in basis to the date of death value. This essentially washes all of a decedent’s capital gains away upon their death. With the repeal of Federal Estate Taxes for persons dying in 2010 also came a repeal of the step-up in basis, forcing heirs to "inherit" their parents’ capital gains. This essentially shifts the burden of death taxes from those with estates over $3.5 million to anyone inheriting appreciated stock, real estate, etc. Some relief is granted as the estate representatives are allowed to "pick and chose" up to $1.3 million in assets that they may receive the step-up in basis on surviving spouses may identify up to $3 million of assets for step-up in basis treatment.

However, all of the "Bush tax cuts" "sunset" on December 31, 2010, returning us to prior tax laws. Accordingly, for persons dying after December 31, 2010, the Unified Credit amount is only $1 million (as it would have been had the 1997 Act remained in place) and the estate tax rate is fifty-five percent (55%) and step-up is reinstated.

However, a provision in EGTRRA provided that if circumstances change between 2001 and 2010, Congress, in its discretion, may retroactively reinstate the federal estate taxes back to January 1, 2010 by September 30, 2010. That is precisely what Congress was in the process of doing. There were three bills working their way through Congress and one bill working its way through the Senate to retroactively reinstate the federal estate taxes back to January 1, 2010. Three of the bills proposed the Unified Credit amount be restored to $3.5 million dollars, and one of the bills proposes increasing it to $5 million dollars. Three (3) of those four (4) bills reinstate step-up in basis, while one (1) does not.

Surprisingly, lobbyists for small businesses, construction companies, manufacturers and other trade groups are lobbying Congress to reinstate the federal estate tax that they have spent years fighting to abolish. The National Federation of Independent Business and more than 40 other business organizations are lobbying the Senate and House leaders asking for quick action on a proposed reinstatement of the federal estate tax Unified Credit amount to $5 million dollars and imposing a proposed estate tax of thirty-five percent (35%).

The reason they have changed positions is to prevent the sunset provisions from kicking in on December 31, 2010, which would reinstate the Unified Credit amount to $1 million dollars and increase the federal estate tax rate to fifty-five percent (55%).

Unfortunately for persons living past December 31, 2010 and fortunately for families of persons who died in 2010, September 30, 2010 has passed and Congress failed to act.   So there are no Federal Estate Taxes on estates of persons dying in 2010 and the Exemption will be $1 million for persons dying in 2011 and after. 

The clock is ticking on estate tax changes because as 2011 nears, so does the prospect that continued congressional inaction (health care reform) would start to bring in billions of dollars in revenue to help reduce the trillion dollar deficits. "That is the real fear," said Rosemary Becchi who lobbies on tax issues for Washington based Patton Boggs, the top lobbying firm by revenue. "Then it becomes extremely difficult to change it."

The non-partisan Tax Policy Center in Washington, D.C. estimated that a revived estate tax at pre-2001 levels would generate more than $34 billion dollars in 2011 and about $410 billion dollars through 2019.

Senator John Kyl (Rep., AZ) and Senator Blanche Lincoln (Dem., AK) have proposed setting the estate tax rate at thirty-five percent (35%). The measure would apply to that portion of estates that exceed $5 million dollars per unmarried individual and $10 million dollars per married couple, and would adjust that exemption for inflation in later years. "The sponsors are negotiating the Senate leaders on ways to bring the plan to the floor for a vote," said Scott Allen, a spokesman for Senator Lincoln. "It is imperative that we come to a resolution on this quickly."

It is unlikely that anything will happen before the election on November 2 or in the lame duck session in December / January.  More than likely reform will pass in the Spring of 2011, retroactive to January 2011.

Keep watch on our webpage, and we will continue to keep you posted as developments progress on this important issue.

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