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The Estate Tax Disappears, For Now

A lot of tax professionals are going to be surprised to learn, when they read this morning’s newspaper, that the estate tax really is going on hiatus effective New Year’s Day.

I am not.

Events have played out pretty much as I anticipated in the commentary that appeared in this space on Aug. 20. Last night, Senate Democrats abandoned their attempts to extend the tax before Congress adjourns for the holidays later this month. This means the tax is going to be officially repealed when the clock strikes midnight on Jan. 1.

Under current law, the tax will only disappear for one year, to return in 2011 at a higher rate (55 percent instead of 45 percent) and with a smaller exemption ($1 million rather than $3.5 million) than currently. The House passed a permanent extension of the tax in its current form earlier this month. But the Senate, preoccupied by the battle over health care reform and stymied by Republican opposition to the “death tax” in any form, could not agree on legislation that would have kept the tax from expiring two weeks from now.

This would be the first time since 1916 that the United States has not had a federal estate tax. (Some states have “decoupled” their estate or inheritance tax laws from the federal system and will retain their taxes next year.) Senate Finance Committee chairman Max Baucus, D-Mont., and House Ways and Means Committee chairman Charles Rangel, D-N.Y., pledged yesterday that Congress will retroactively restore the estate tax during the early part of next year, preventing an interruption. I would not bet on that.

It is not entirely clear that Congress can retroactively preserve the tax. Executors are required to file estate tax returns for decedents with enough assets to be subject to the tax. But, in the absence of an estate tax, a large estate might not even need an executor. Assets can be transferred in trust or by other means, such as joint tenancy, without the need to have a probate court appoint an executor. Though the recipients of taxable assets can be liable for the tax, they do not necessarily have access to the information to prepare a return to calculate it. Tracking them down would be an administrative nightmare, if not an outright impossibility, too.

Even a fairly brief period without a tax will make it likely that some sizeable estates will be entirely liquidated before Congress can restore a filing requirement. Would the courts uphold a tax obligation imposed after the fact? Nobody knows, but I think there is a good chance they would not.

Besides the practical considerations, there is politics. It is one thing to continue an existing tax; it is quite another to impose one that is no longer in effect. An estate tax hiatus gives Republicans a perfect opportunity to beat Democrats with the old tax-and-spend stick during next year’s campaigns. Republicans could hardly have drawn up a better scenario for themselves than a health care overhaul that has much of the public worried, multiple rounds of “stimulus” spending amid a flood of federal red ink, and a Democratic push to restore a tax that the public does not much like even though most people never pay it.

The same Republican opposition that prevented an extension of the tax this year will only intensify next year, while Democratic support for the tax is almost certain to weaken.

Both parties will be eager to prevent the tax from returning in its harsher form at the end of 2010. Republicans, however, have no reason to address the issue early in the year. They will want to wait until after the elections (to preserve the issue for the campaigns), and then — with the likelihood of a smaller Democratic presence in the next Congress — deal with the subject late in the year.

And, in the unlikely but not inconceivable event that Republicans actually win a majority in at least one house of the next Congress, they may decide to hold off even longer to give themselves more leverage. Retroactive repeal or relief from the harsher tax of 2011 will be much easier to implement, if not to finance, than retroactive reinstatement of the tax in 2010.

In any event, Americans are going to discover next month that life can go on without a “death tax.”

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 recently updated 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.” Larry was also among the authors of the firm’s book The High Achiever’s Guide To Wealth.

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