If Estate Tax is the Answer, What’s the Question?

As the nation moves rapidly toward what is commonly known as “the fiscal cliff,” when a slew of automatic budget cuts and increased tax rates take effect simultaneously (January 1, 2013), many are wondering if Congress will be able to come together before their pending deadline.  The fiscal cliff was initially created largely due to the inability of Congress to agree on a budget ahead of the government’s potential credit default during the “debt ceiling debate” last year.  Congress agreed to a number of automatic budget cuts and temporary, but expiring, extensions of policy, effectively betting on themselves to get a budget deal by the end of this year.

Rep. Jim McDermott (D-Wash.) indicated recently that he believes the estate tax may be a large part of the answer to the federal budget woes.  In order to avoid “falling off the cliff,” Congress needs to find over $1 trillion of budget cuts, tax increases, or some combination of the two.  According to McDermott, who introduced the Sensible Estate Tax Act, a significant portion of the gap could be closed by reverting the estate tax applicable exclusion amount back to 2001 levels as adjusted for inflation.  This means that the applicable exclusion amount will be somewhat higher than $1 million, or up to $2 million for married couples.  Additionally, the proposal would makeportability permanent for married couples who file an estate tax return on the first spouse’s death.

The proposal is unlikely to gain any traction in the House of Representatives; indeed it was originally proposed in November 2011 and the Republicans in the House are clamoring for repeal of the tax.  Additionally, it is a more aggressive estate tax proposal than most Democrats are willing to support.  However, there is another problem with using the estate tax to close major budget gaps: with the right combination of planning and time, nearly everyone can completely avoid the estate tax.  It is the closest the existing tax structure comes to being optional.

Even at the decreased estate tax rate, only a limited number of millionaires will exist in the country and be required to pay the tax.  However, with all the publicity the estate tax has received in recent years, this sharp increase in both the amount of taxable estates and the rate at which such estates will be taxed should spur people to action and get them planning for the succession of their businesses, real estate, and other assets to their heirs.
Depending on the amount of the estate that will be taxable, more aggressive planning may be necessary, including irrevocable trusts, and business entity planning.  However, for a significant number of taxable estates, annual gifting may be sufficient to remove a most of the taxable funds.  Additionally, for people who own a home as their primary asset, certain types of trusts may remove some of that non-liquid value from the estate.  As such, projected estate tax revenues may not be the best solutions to substantial budget shortfalls, even if Bill Gates, Sr. supports it!

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