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Will Estate Taxes Really Disappear?

Congress will have a lot on its plate when lawmakers reconvene in September. Besides health care, which has dominated the headlines this summer, the administration wants action on climate change and financial regulation.

Notice that I did not mention taxes. Apart from the question of how to pay for expanded health coverage, tax legislation has been out of the news for months. This is very odd, because, unless Congress acts before midnight on New Year’s Eve, the estate tax that has been in effect for decades is going to go away, at least temporarily.

As I have suggested several times over the years, I think this would be a good thing. But most Democrats in government, not to mention most other professional estate planners, disagree. Current law, enacted in 2001, would repeal estate taxes in 2010, but would reimpose them in 2011 under older, harsher terms than what we currently have. The top rate would go from today’s 45% to 55%, and the tax-free exemption would drop from $3.5 million to $1 million.

But first there would be that one-year holiday from the tax in 2010. Practically from the minute the 2001 law was signed, most commentators predicted that Congress would keep the tax intact. Republicans fought for a few years to make the repeal permanent, but the Democratic takeover of Congress in 2006 seemed to doom that effort.

At an estate planning conference I attended in May, a speaker asked how many attendees thought there was any chance the estate tax might really expire on January 1. There were about 150 professionals in the room. I was the only one to raise my hand.

The speaker pointed to me and asked why I thought repeal was possible. “Congressional inertia,” I replied. The legislative process makes it much easier to prevent something from being done than to actually do something, as President Obama and his allies in the health care fight are discovering.

So the folks who want to repeal estate taxes merely have to run out the clock. Lawmakers will have a bruising fight over health care when they get back to Washington. Then they will turn to other legislative priorities. Democrats probably have the votes to push through an extension of the estate tax before it expires at the end of this year. But I can see several scenarios in which the estate tax would die on January 1.

Scenario #1: Either because of other priorities or due to Republican blocking maneuvers, no tax bill makes it through Congress in 2009. That will enable opponents of the tax to claim next year (which, of course, is a Congressional election year) that tax-and-spend Democrats want to bring it back. Some Democrats in swing districts may not want to expose themselves to those attacks. I think it will be much harder to restore the estate tax once it goes away than it would be to simply extend it while it is in force.

Scenario #2: Estate tax repeal becomes part of a bargain to pass some sort of health care overhaul. For good or ill, Democratic leaders have made health care their top legislative priority. This could give legislators on both sides of the aisle a lot of leverage to push for something else, such as a tax bill that does not extend the estate tax, in exchange. Interestingly, some of the most important health care negotiations are taking place in the Senate Finance Committee, whose chairman, Montana Democrat Max Baucus, is one of the few members of his party who has called for estate tax repeal. Also, the administration would love to require most small businesses to provide health coverage. Business groups including the U.S. Chamber of Commerce are fiercely resisting. But those same business groups are among the strongest backers of estate tax repeal. There may be room for political horse-trading here.

Even a brief hiatus from the estate tax would create enormous planning opportunities for wealthy families that happen to experience a death during the gap. I am already making contingency plans in a few cases to move at warp speed in administering the estates of clients whose age or health raises the possibility that they might die in the upcoming year.

My logic: If assets have been distributed to beneficiaries who invested or spent the money in good faith and in full compliance with existing law, is the government really going to come back for a retroactive tax — and will the courts permit it? If not, will the public support reinstating the estate tax after some families, through an accident of timing, have been allowed to escape it?

For a levy that hits only the wealthiest 1 percent to 2 percent of the population, the estate tax has surprisingly little popular support to begin with. It does not generate an important amount of government revenue. I think many people’s sense of fairness might lead them to oppose resuscitating the tax if it dies.

I would be delighted to see the estate tax go away. In 2001, when repeal legislation was under consideration, I called it a lousy tax. I still believe that. I am realistic enough to know that the odds favor its continuation, especially with Democrats controlling Congress and the White House. But the game is not yet over. Stay tuned.

Larry M. Elkin is the founder and president of Palisades Hudson, and is based out of Palisades Hudson’s Fort Lauderdale, Florida headquarters. He wrote several of the chapters in the firm’s book, Looking Ahead: Life, Family, Wealth and Business After 55. His contributions include Chapter 1, “Looking Ahead When Youth Is Behind Us” and Chapter 4, “The Family Business."

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One Response to "Will Estate Taxes Really Disappear?"

  • Russell Patton III, CPA, CFPtm
    October 23, 2009 - 4:29 pm

    The stepped up basis makes too much sense for the taxing authorities to continue!

    The original basis figures may have expired long before the dead taxpayer.