Congress is rapidly running out of time to address the “disappearing” estate tax set to occur on January 1, 2010, so individuals should stay abreast of the latest developments.

As the law currently stands, the federal estate tax will disappear January 1, 2010, and then re-emerge in 2011 with the threshold for taxation lower than has been seen in nearly a decade.  The law currently slated to take effect in 2011 provides for an estate tax exemption of $1 million per person and a tax rate as high as 55 percent.  The current regime provides for a $3.5 million estate tax exemption per person and a tax rate as high as 45 percent.  In light of the current state of the budget, it is unlikely that Congress will let the estate tax expire next year.  Nor is it likely that Congress will bring back the higher tax levels not seen since 2001.  Thus, the question remains, just what is Congress going to do?

While it is impossible today to know for certain what final estate and gift tax legislation will provide, the pending legislation introduced in the House of Representatives and the Senate provides some insight into the changes being contemplated.  Summarized below are several of the proposals that have captured the greatest levels of attention from both the general public and tax planners. 

In general, these pending proposals tend to address (or not address) the following key aspects of estate and gift tax legislation:

  • Repeal:  Whether to permanently repeal the estate tax or to continue the estate and gift tax regime
  • Estate Tax Exemption:  What amount each person should be permitted to pass free of estate tax, and whether the amount should be indexed for inflation
  • Top Tax Rate:  Which top tax rate to impose on estates and gifts in excess of the exemption amounts
  • Unification of Estate and Gift Tax Exemptions:  Whether to unify the estate and gift tax exemptions, so that each person has a total exemption amount that he or she may use to make gifts during life or bequests at death  (While the current estate tax exemption is $3.5 million, the gift tax exemption is $1 million.)
  • Portability:  Whether to permit a surviving spouse to use a deceased spouse’s unused exemption amount (For example, today a married couple theoretically could pass $7 million in assets estate tax-free, by utilizing each spouse’s $3.5 million exemption.  However, if the first spouse to die only had $2 million in assets, and the surviving spouse had $5 million in assets, the first spouse could not transfer his or her unused $1.5 million exemption to the second spouse.  The surviving spouse’s estate would be subject to estate tax on $1.5 million—$5 million in assets reduced by the $3.5 million exemption.  The proposed portability provisions would allow the unused exemption amount of the first spouse to die to pass to the surviving spouse, allowing a married couple to maximize the use of their available exemptions, regardless of how their assets are held as between themselves.) 
  • Basis in Inherited Property:  Whether to continue to provide for a step-up in basis for inherited property or to continue carryover basis, which presently is scheduled to apply only for 2010  (Under current law, the basis in a decedent’s assets is “stepped-up” to date of death values so the assets can be sold without a taxable gain.  With “carryover basis,” as the name implies, basis does not change at the decedent’s death.)
  • Discounts:  Whether to eliminate certain discounts, such as discounts for lack of marketability and for minority interests, applicable when valuing entities that are owned by related parties, to the extent such entities own passive investments

The characteristics of the most widely discussed proposals are detailed below.  To view a summary table of the characteristics of the proposals, please click here.  To view a table of all pending proposals to modify the federal estate and gift tax, please click here.  As Congress introduces additional proposals, the charts will be updated accordingly, so please be sure to check back here regularly.

Obama Administration

The Obama administration, as part of its budget proposal, favors reforming the estate and gift tax as follows:  

  • Repeal:  No permanent repeal
  • Estate Tax Exemption:  $3.5 million, indexed beginning in 2011
  • Top Tax Rate:  45 percent
  • Unification of Estate and Gift Tax Exemptions:  No; gift tax exemption to remain at $1 million
  • Portability:  No
  • Basis in Inherited Property:  Retain current rule to step-up basis at death
  • Discounts:  n/a

The Obama administration’s proposal also would limit the effectiveness of grantor retained annuity trusts (GRATs), a popular wealth transfer tool.  The proposal would require a minimum 10-year term for each GRAT.  Because GRATs fail if the grantor dies during the term, the longer required term would increase the probability of failure.

The Pomeroy Bill (H.R. 436)

On January 9, 2009, Rep. Earl Pomeroy (D-ND) introduced the first bill of the current Congress addressing estate and gift tax reform.  The key features of the Pomeroy Bill are as follows:

  • Repeal:  No permanent repeal
  • Estate Tax Exemption:  $3.5 million, no indexing
  • Top Tax Rate:  45 percent; a surtax applies to estates over $10 million, designed to phase-out the estate tax exemption and rates below 45 percent
  • Unification of Estate and Gift Tax Exemptions:  No; gift tax exemption to remain at $1 million
  • Portability:  No
  • Basis in Inherited Property:  Retain current rule to step-up basis at death
  • Discounts:  Restrictions on discounts for transactions involving entities owned by related parties, to the extent such entities own mainly passive investments

The Mitchell-Kirk-Nye Bill (H.R. 498)

On January 14, 2009, Rep. Harry Mitchell (D-AZ), Rep. Mark Kirk (R-IL) and Rep. Glenn Nye (D-VA) introduced H.R. 498, also known as the Capital Gains and Estate Tax Relief Act of 2009.  The key features of H.R. 498 are as follows:

  • Repeal:  No permanent repeal
  • Estate Tax Exemption:  $3.75 to $5 million from 2010 to 2015, indexed beginning in 2016
  • Top Tax Rate:  Capital gain tax rate for estates up to $25 million (presently 15 percent); double the capital gain tax rate for estates over $25 million (30 percent)
  • Unification of Estate and Gift Tax Exemptions:  Yes 
  • Portability:  Yes
  • Basis in Inherited Property:  Retain current rule to step-up basis at death
  • Discounts:  n/a

The Baucus Bill (S.722)

On March 26, 2009, Senate Finance Committee Chairman Max Baucus (D-MT) introduced S.722, called the Taxpayer Certainty and Relief Act of 2009.  Title III of this proposal is entitled “Permanent Estate Tax Relief.”  The key features of the Baucus Bill are as follows:

  • Repeal:  No permanent repeal
  • Estate Tax Exemption:  $3.5 million, indexed
  • Top Tax Rate:  45 percent
  • Unification of Estate and Gift Tax Exemptions:  Yes 
  • Portability:  Yes
  • Basis in Inherited Property:  Retain current rule to step-up basis at death
  • Discounts:  Maximum value reduction of $3.5 million for farm and business assets

One should note that the Baucus Bill in its current status cannot be adopted, as tax legislation must originate in the House of Representatives.  However, all or part of the bill could be added as a Senate amendment to a House-passed tax bill.

The McDermott Bill (H.R. 2023)

On April 22, 2009, Rep. Jim McDermott (D-WA), the fourth most senior Democrat on the House Ways and Means Committee, introduced H.R. 2023, called the Sensible Estate Tax Act of 2009.  The key features of the McDermott Bill are as follows:

  • Repeal:  No permanent repeal
  • Estate Tax Exemption:  $2 million, indexed beginning in 2011
  • Top Tax Rate:  45 percent for estates up to $5 million, 50 percent for estates of $5 to $10 million, and 55 percent for estates over $10 million 
  • Unification of Estate and Gift Tax Exemptions:  Yes; gift tax exemption to increase to $2 million
  • Portability:  Yes
  • Basis in Inherited Property:  Retain current rule to step-up basis at death
  • Discounts:  n/a

What You Should Do

Congress is rapidly running out of time to address the “disappearing” estate tax set to occur on January 1, 2010.  Although the House and Senate have introduced numerous bills, none has yet passed into law.  Given the approaching deadline, check here regularly to stay abreast of the latest developments.