The State of the Estate Tax – Thoughts for December 2012

This month feels a lot like November of 2010. Once again, we are waiting to see whether Congress will act by year end and, if so, what estate tax solution they will come up with.

There are potentially millions of dollars at stake for people with taxable estates.  If Congress fails to act by the end of the year, the estate tax exclusion will drop from $5.12 million to $1 million, meaning that anyone with a taxable estate worth more than $1 million could be subject to estate tax. At the same time, the estate tax rate could increase from 35 percent to as high as 55 percent, taking more than half of the estate.

The taxable estate includes many items that people don’t normally think of as assets, such as life insurance. By the time these assets are factored in, a $1 million exclusion would hit a much larger portion of the population than a $5 million exclusion.  This has many moderately-wealthy individuals on pins and needles as we get closer to 2013.

Given the rampant speculation about what could happen, I thought I’d throw my guesses in the hat.  But they are just that – guesses. Educated guesses (hopefully), but still guesses.  With that warning aside, here are my thoughts.

I Don’t Think We Will Return to a Pre-EGTRRA Estate Tax Environment

The Taxpayer Relief Act of 2010, which was enacted in late December 2010, gave us the current $5 million exemption, 35 percent estate tax rate, and portability of the deceased spouse’s unused applicable exclusion amount, among other things.  But that law wasn’t a new law as much as a modification of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).

EGTRRA (as amended and extended by the Tax Relief Act of 2010) was built to self-destruct if not extended by Congress. As a result, if Congress doesn’t act by the end of the year, in 2013 we will return to the law that was in effect prior to EGTRRA.  The federal exclusion amount will drop to $1 million, the maximum tax rate will rise to 55%, and portability will disappear.

Thankfully, I think this is the least likely alternative. I have followed the estate tax dialog fairly closely, both in 2010 and this year. I don’t hear a credible voice calling for a return to pre-EGTRRA law.

In an all-Democrat Congress, the exclusion would likely be set at $3.5 million with a 45 percent rate; in an all-Republican Congress, the estate tax would likely be repealed. We may disagree about which of these is correct on policy grounds. But, no matter which side you are on, I think these are the best and worst case scenarios and that the solution will fall somewhere in the middle. There are simply no credible advocates for a $1 million exclusion and a 55 percent maximum rate.

Of course, this assumes at least some degree of Congressional cooperation.  Congress could end up deadlocked in political bickering, in which case we would return to pre-EGTRRA law by default.  If that happens, it wouldn’t be because either party wanted it, but because they couldn’t reach a suitable compromise.

I have failed to appreciate the full extent of Congress’s ineptitude in the past.  I expected Congress to act before the end of 2009 and would have bet against the full repeal of the estate tax for 2010. I was wrong then, and I could be wrong now. But I just don’t see this as a real likelihood. I believe that Congress will act prior to year end.

Two More-Likely Scenarios

Given that I don’t think that we will return to pre-EGTRRA law, I see two likely scenarios: Congress defers a decision by extending the current law ($5.12 million exclusion, 35% tax rate) into 2013, or Congress lowers the exclusion to $3.5 million and raises the maximum rate to 45 percent.

The possibility of a $3.5 million exclusion and a 45 percent tax rate has been a favorite of Democrats in the past and has been included in President Obama’s budgets.  I don’t rule that out as a possibility, but I think the extension of the current law is the most likely.  The estate tax debate is part of a much larger dilemma about how to overhaul our tax code, and there’s not bipartisan consensus on that topic.  In situations like this, history has shown a Congressional penchant for procrastination. Kick the can down the road, we’ll figure it out later.  That’s what I think will happen in December.

Leave a Reply