That’s the $5 million question.
More precisely, for 2012, it’s the inflation-adjusted $5,120,000 question.
If you’ve followed the wrangling over the estate tax for the past 10 or 15 years, you know that it is a highly-charged political issue. It lies directly along the fault line that separates the anti-tax enthusiasts in Congress from those who believe that the wealthy aren’t paying enough taxes.
The lifetime exclusions from the federal gift and estate taxes have increased considerably over the past several years. As a result, for the present time at least, federal gift and estate taxes have been eliminated as a concern for the middle class. A married couple may now transfer $10,240,000 to their children without paying federal gift or estate taxes. I assume that to most Americans, couples who have $10 million to pass along to their children aren’t exactly middle class. Others may define “middle class” more broadly and argue that a couple owning $10 million in assets is merely “comfortable,” but not wealthy.
In any case, whether you believe that today’s $5 million per person lifetime exemption ($10 million per married couple) is too high, too low or “just right,” those figures are destined to expire at the end of 2012. Unless Congress acts, the gift and estate taxes will revert to the laws that were in effect in the year 2001. That means only a $1 million per person ($2 million per married couple) lifetime exemption from the federal gift and estate taxes. (The lifetime exemption from the third wealth transfer tax, the Generation-Skipping Transfer Tax (GSTT), will be a somewhat larger number, since the $1 million GSTT exemption was indexed for inflation under the law in effect in 2001.)
What is especially disconcerting about the fluid state of the wealth-transfer taxes is that planning to reduce or avoid the taxes is challenging at best. Anecdotally, many families have resisted updating their estate plans for years, waiting for Congress to agree on and stick to lifetime exclusions and tax rates (which have themselves declined substantially since 2001) for the gift and estate taxes and the GSTT.
A bit of history is in order. In 2001, Congress passed and President Bush signed into law the Economic Growth and Taxpayer Relief Reconciliation Act (EGTRRA). EGTRRA gradually increased the lifetime exemptions from the estate tax and GSTT until they reached $3.5 million in 2009. The rates for both taxes were likewise gradually reduced from marginal rates that could reach as high as 60% for the estate tax to a maximum marginal rate of 45% for each tax.
Under EGTRRA, the estate tax and GSTT were slated to expire in 2010. Because of budgetary constraints and Senate budget rules which would have required an unattainable 60 votes to permanently repeal the taxes, the repeal was for one year only. In 2011, the pre-EGTRRA taxes would be reinstated as they existed in 2001, as though EGTRRA had never been signed into law. The evident intention was that both taxes would be permanently repealed by a later and more sympathetic Congress.
EGTRRA did not repeal the federal gift tax. This omission was intended to prevent families from gaming the system for income tax purposes by gifting assets to those best able to utilize the assets’ income tax attributes, especially unused capital gains and losses.
Of course, there was little doubt that Congress would revisit the wealth-transfer taxes to avoid the absurdity of a one-year repeal of the estate tax and GSTT, followed by their revival in 2011 with much lower exemptions and much higher tax rates than had been in place in 2009.
Congress surprised everyone by failing to effectively address EGTRRA prior to 2010. Only in December of that year did Congress act, serving up a legislative hash that gave the estates of persons who had died in 2010 the option of paying an estate tax or paying income tax on untaxed capital gains in the decedent’s estate. In other words, carryover basis would replace the basis step-up at death.
In the 2010 tax act (the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010) (TRUIRJCA), President Obama agreed with Republican leaders to reinstate all three of the wealth transfer taxes, each with a lifetime exemption of $5 million (adjusted for inflation beginning in 2012) and a maximum tax rate of 35%. As indicated above, for 2012, the inflation-adjusted exemptions are set at $5,120,000. The TRUIRJCA accord, however, expires at the end of 2012. At that time, as was the case with EGTRRA, the wealth transfer taxes will revert to year 2001 lifetime exemptions and tax rates. Will Congress finally act and give us the stability in the law that will permit American families to plan for reducing and paying the wealth transfer taxes?
It’s been a long road getting from 2001 to where we are today. Sadly, however, that’s not the finish line you see up ahead; it’s the starting line. We’re back to where we began, not knowing what the law is going to be from one year to the next.