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Estate Tax Dilemma - Which Rates To Assume? In RELIEF 2001, Congress created a level of complexity and uncertainty unknown even in past tax acts. The estate tax exemption equivalent was renamed the applicable exclusion amount, and increased to $1 million in 2002, $1.5 million in 2004, $2 million in 2006 and $3.5 million in 2009. The top rate is reduced to 50% in 2002, 49% in 2003, 48% in 2004, 47% in 2005, 46% in 2006 and 45% in 2007. However, in 2010, the entire estate tax is repealed and replaced with a gift tax, with the top gift tax rate set at the top then-existing income rate. Finally, under the "sunset" rule in the Senate, the entire tax act sunsets in 2011 and the 55% top rate and $1 million exemption that previously was planned for 2006 are restored. This very unusual result of the political process presents a major dilemma for those who are planning for transfer of their estate. What rates should be used? Will Congress change estate tax rates before 2010? How likely is a future freeze? While it is very difficult to predict Congress, the forthcoming budget pressures suggest that the probability to implement each increase in the exclusion and decrease in the estate tax rates can be estimated for years 2006, 2007, 2009, 2010 and 2011. 2006 - Top Rate 46% - Exclusion $2 Million. It is very probable that the increase in the exemption to $2 million and the reduction in rates to 46% will take place by 2006. The cost each year for this change is approximately $6 billion. In the framework of the entire federal budget, this is a reasonably small amount and the change benefits quite a few small business owners and farmers. In addition, there seems little chance of changing the estate tax top rate and applicable exclusion before the next Presidential election in 2004. Thus, the likelihood that the 2006 change will take place is rated as "Very Probable." 2007 - Top Rate 45% - Exclusion $2 Million. It is quite probable that the final reduction in rates to 45% will take place. The higher estate tax rates have historically been very substantial levies of tax. Many in Congress have felt that the rate should be lower, even if the estate tax is retained. Thus, the likelihood that the 2007 changes will take place is rated as "Quite Probable." 2009 - Top Rate 45% - Exclusion $3.5 Million. It is less probable that the $3.5 million exemption will be created. The Congressional Budget Office estimated that the tax cost of this change would be approximately $24 billion per year in 2009. Thus, even in federal government terms, it costs significant resources to implement this change. For this reason, the likelihood of an increase in the exemption to $3.5 million is rated "Less Probable." 2010 - Repeal of the Estate Tax. The repeal of the estate tax is substantially less probable. Clearly, when RELIEF 2001 was passed, there was insufficient funding available to cover the anticipated $54 billion per year cost of repeal of the estate tax. For this reason, repeal was deferred the maximum ten years under the Senate rules. Since there still will be major cost in 2010, repeal will occur only if there are major new sources of revenue available. Given the desire of the President to create private accounts for Social Security, modernize the Department of Defense, add a prescription drug benefit to Medicare and increase other federal programs, there will need to be dramatic growth of the economy over the next decade to generate the level of revenue necessary for the repeal of the estate tax. In addition, if the exemption is at that time $2 million or even $3.5 million, the number of individuals affected by the estate tax will be reduced to perhaps one-fifth of one percent of the nation. Thus, it will be difficult to build a consensus for estate tax repeal with such a small supporting constituency and a large cost. The rating for estate tax repeal is "Substantially Less Probable." 2011 - Top Tax Rate 55% - Exclusion $1 Million. There is virtually no chance that the estate tax will be repealed in 2010 and reinstated in 2011, as if RELIEF 2001 had not existed. Under the 10-year "sunset" rule of the Senate, it was essential to include legislation that would repeal all the changes and reinstate prior law. However, it is almost inevitable that there will be a major tax bill by 2005 or 2007. At that time, the entire question will be reviewed again. It is very possible that there is yet another phase-out plan created, with the final date for estate tax repeal pushed back to 2015. However, 2016 is currently the year when Social Security is scheduled to go into the red. While it is difficult to project the result after 2010, repeal in 2010 followed by reinstatement of the prior estate tax structure in 2011 is rated: "Virtually No Chance." |
