Playing Chicken with Estate Tax Laws
by Dave Evans
The federal estate tax has been a moving target for Americans to calculate. The James Dean movie, “Rebel Without a Cause,” has a famous scene: Following a knife fight that Dean's character Jim Stark was forced into by jealous protagonist Buzz Gunderson, Stark is challenged to a game of “chicken run,” which involves racing stolen cars toward a cliff. The person who jumps out first loses and hence is chicken. While it’s common to view this type of a movie scene in a detached way, the reality is that Americans are contestants in a much larger game of chicken, called “What is Congress going to do and when?” Many people used to believe that a divided Congress is actually a good scenario because it can’t overregulate and pass bad legislation. But because of the sunset rules that sometimes pertain to legislation, inaction by Congress is not necessarily a good thing; no action can become defacto action. A good example of this can be found within the recent status of estate tax laws.
Over the years, the estate tax has varied in a number of different aspects, particularly the exemption level and marginal tax rates. Since estate taxes can be viewed as a permanent consideration—setting aside gift taxes—it is important for people to make sure they have adequate funds to pay the taxes, so as not to require a forced sale of assets—particularly a closely held business—to pay the taxes.
The problem is that the federal estate tax provisions have been a moving target for affluent Americans to calculate. If someone died in 2000, he would have owed a tax of 55% on estates of more than $1 million, not passed onto a spouse.
Yet when George Steinbrenner died in 2010, his estate owed no federal estate tax, thanks to the Economic Growth
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and Tax Relief Reconciliation Act of 2001 (EGTRRA). That act started with an estate tax unified credit exclusion of $675,000 in 2001, but increased in steps from $1 million in 2006 to $3.5 million in 2009, with repeal of the estate tax and generation-skipping tax scheduled for 2010. But Congress never made the elimination of the federal estate tax permanent, so the estate tax returned.
In 2011, the estate tax came back at a maximum rate of 35%, with a $5-million exemption for individuals and $10-million exemption for married couples. For 2012, if the spouse who dies first fails to use up the full $5.12-million exemption, it carries over and can be added to the second spouse’s $5.12 million exemption. Additionally, the annual gift exclusion remains $13,000 per year, and gifts of tuition and payments of medical care are still exempt.
Now the game of congressional chicken comes into play: Under the current law, the estate tax exemption is scheduled to drop significantly from $5.12 million in 2012 to $1 million in 2013, and the estate tax rate is scheduled to jump from 35% to 55%.
So if you are a closely held business owner or an advisor to one, is your advice not to worry because the threshold will be raised to $3 million or $5 million anyway? And will the tax rate be 35%, 45% or even 55%? The problem is that the estate tax has been kicked down the road by Congress for a decade, and it creates a paralyzing effect on client behavior as they assume the can will continue to be kicked down the road. But just like in “Rebel without a Cause,” be sure not to have an accident.
Independent Insurance Agents of New Mexico - www.iianm.org - * July 2012