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 Charlie Douglas, JD, CFP®, AEP®, Editor
Email:
editor@naepcjournal.org
Phone: 404.279.7890
A plausible estate planning twist to
John Lennon's song, Imagine might read:
Imagine there's no Estate Tax
It's easy if you try
No transfer tax to plan for
Pass it all on when you die
It was just a year ago around this time that many estate
planning practitioners, including this one, were counseling
ultra affluent clients to plan for making taxable gifts to their
heirs at the end of the year. There was a palpable feeling among
many advisors that the transfer tax environment, with a 35% gift
tax rate and a $1,000,000 gift tax exclusion, was "as good as it
gets."
Then on December 17, 2010 Congress shattered that notion with
the Tax Relief, Unemployment Insurance Reauthorization and Job
Creation Act of 2010 ("TRA 2010") and "as good as it gets," got
even better. TRA 2010 unexpectedly embodied a bold $5 million
combined estate, gift and generation skipping tax exclusion, at
a universal transfer tax rate for estate, gift and generation
skipping transfer tax purposes of 35%.
Even so, is it plausible that the modern day estate tax which
has been with us since 1916 will soon receive the final death
nail and be repealed?
Death to the "Death Tax"
The GOP has for years successfully labeled the estate tax as
a "death tax," where property is unjustly subject to being taxed
a second time. Garnering public support, the GOP has won many
political battles in limiting the death tax's reach. Still, some
conservatives won't rest until the death tax is finally dead.
Note, all GOP candidates running for president make no provision
for an estate tax as part of his/her comprehensive tax reform
platform.
Standing in stark opposition to this one-sided view is the
current administration, which in a recent report released by the
White House's Office of Management and Budget, explicitly stated
that "the Administration remains opposed to the extension of
these high income tax cuts past 2012 and supports the return of
the estate tax exemption and rates to 2009 levels ($3.5 million
for estate tax purposes; $1 million for gift tax purposes; and a
maximum transfer tax rate of 45%).
Liberals are sure to argue that we are drowning in deficits
and that this is no time to be giving the more affluent of the
richest 1% another tax windfall. Furthermore, America needs a
more encompassing estate tax because it undergirds America's
traditions rooted in meritocracy and upward mobility.
Conservatives will inevitably counter by pointing out that
with such a fragile economy this is not the time to be raising
taxes of any kind, particularly those where small businesses and
family farms will have to be needlessly sold to pay the
excessive death tax. Additionally, they will demand that the
death tax be repealed because it ties up capital, punishes
saving and investing, undermines job creation and further
stifles wages and productivity.
The Super Committee's Super Flop
Pursuant to the Budget Control Act of 2011, the special
committee of Congress (a.k.a the "super committee") had until
Nov. 23rd, 2011 to issue a formal proposal containing at least
$1.2 trillion in deficit reduction for the full Congress to
consider. As the committee neared decision time, rumors began to
fly over ways to raise revenue, including speculation that the
super committee would reduce the estate and gift tax exclusions
back to 2009 levels.
Some speculated that the gift tax exclusion amount would be
decreased to $1 million effective January 1, 2012 instead of
January 1, 2013. Others postulated that the decrease would take
effect on November 23, 2011. In the end, however, there was to
be no deal, big, small or otherwise. Political gridlock
regarding taxes and entitlements once again ruled the day and
the committee tragically punted altogether.
Think about the significance of that miscue for a moment. We
have a projected deficit over the next 10 years of $44 trillion
and the super committee could not even come up with $1.2
trillion in cuts over the same period.
Regardless, austerity is sure to make its way to America as
the markets will demand it as they are exacting from Europe
today. Alarmingly, gross federal debt is a whisker away from
100% of GDP in the United States. In time, spending will need to
be slashed and revenue raised, but that does not mean that the
modest estate tax will be an effective vehicle for increasing
revenue on a go forward basis.
Preapproved $1 Million Exemption in 2013 Lacks Staying Power
It is difficult to imagine that during this upcoming election
year either party has the political stomach to seriously address
entitlements and tax reform. After all, the super committee with
its extraordinary and unprecedented "super powers" flatly
failed, so why should the full-body of Congress, who cannot seem
to agree on much these days, suddenly strike a deal on this long
running and contentious issue at the same time they are
campaigning for re-election?
Perhaps influential Senator John Kyl (R., Ariz.) may push for
a deal before he retires at the end of 2012 as some
conservatives may be eager to forge a deal that would overhaul
the tax code before 2013 in order to avoid a higher tax burden
on the wealthy. Still, plan on 2012 feeling an awful lot like
2009, where the threat of returning to 2001's $1 million
exclusion looms large.
Conceivably, the most likely scenario is that we actually
begin 2013 with 2001's $1 million exclusion since it is already
preapproved and requires no further act of Congress. Thereafter,
the somber negotiations on deficit reduction and comprehensive
tax reform are likely to begin in earnest.
It is doubtful that the $1 million exclusion, if realized,
will actually hold up as history suggests that once Congress
provides a tax benefit it is reluctant to take it away. For
example, the last time Congress reduced the estate tax exclusion
amount was during the 1930s. Many commentators feel that the "$5
million exclusion genie" along with portability have already
been freed from the bottle and will not return.
Whatever deal, if any, which may ultimately be struck on the
budget deficit and comprehensive tax reform, a retroactive
application back to January 1, 2013 seems plausible.
Could Killing the Death Tax be Good for the Economy and the
Deficit?
Evidence appears to be mounting that killing the death tax
could even be good for the economy and the deficit. A study
recently commissioned by the American Family Business Foundation
which was conducted at the Institute for Research on the
Economics of Taxation opined that a repeal of the estate tax
would increase GDP by 2.26% by 2021 and that a repeal would
generate enough revenue over a ten year period to cover almost a
third of the current $1.2 trillion in deficit reduction.
Some States have already reached this conclusion. Effective
January 1, 2013 Ohio will repeal its 120 year old estate tax.
Ohio concluded that estate taxes primarily produce flight where
business owners flee high-tax states for low-tax or no-tax
states, destroying wealth and driving away job-creating business
owners.
Ohio is not alone in its beliefs. A 2008 study by the
Connecticut Department of Revenue Services named the estate tax
the primary reason wealthy residents left the state, oftentimes
taking their businesses with them. The study also revealed that
economies of states without estate taxes grew 50% faster, and
created nearly twice as many jobs, than states with death taxes.
Expansive Income Tax Reform May Trump the Existing Estate
Tax Trickle
While it is exceedingly difficult to accurately predict what
the outcome of budget and tax reform will be, it is not hard to
conceive of a state of affairs where the estate tax card gets
discarded in favor of shoring up the income tax hand.
Assuming Congress callously continues to borrow 40 cents for
every dollar it spends, it will need to raise in excess of $2
trillion dollars of revenue annually. If, on the other hand,
Congress currently funds the amount of government that is being
provided, annual tax receipts would need to be closer to $3.5
trillion.
At this time, the vast bulk of tax revenue (over 80%) comes
from income and Social Security taxes. Conversely, the amount of
tax revenue presently being derived from estate taxes hardly
amounts to a financial trickle. According to the Congressional
Research Service, at a $5 million dollar exclusion, the estate
tax applies to just 1.4 decedents out of 1,000, where it is
expected that only $11 billion in annual revenue will be raised
at a transfer tax rate of 35%. And $11 billion dollars of
revenue raised annually contributes only .321 percent toward the
$3.5 trillion needed for the government's estimated annual
budget.
Perhaps a repeal of the estate tax will be part of the trade
off for both higher and more progressive income tax rates, or
possibly swapped for simplifying the code by lowering rates and
ridding the system of many loopholes.
Or maybe there will be estate tax repeal in exchange for a
capital gains tax on all appreciated assets transferred at
death. Although the loss of step-up in basis on appreciated
assets transferred would be burdensome, there are nevertheless a
number of distinct advantages, including: eliminating the
"double tax;" heirs getting to choose when to trigger a tax as
opposed to the estate imposing one on them; and having a
presumably lower capital gains tax rate as opposed to a higher
estate tax rate.
A De facto Estate Tax Repeal Already Exists
Although few practitioners believe that the estate tax will
actually be repealed, many more firmly believe that portability
and the $5 million dollar exclusion are here to stay. Should
they be correct, then the "death tax" has already been de facto
repealed for more than 99% of Americans. According to estimates
from the Tax Policy Center there are only an estimated 3,300
estates in the U.S. that would owe federal estate taxes under
the current threshold of $5 million.
It is no secret that the majority of the public fail to plan
their estates because they lack a sense of urgency and awareness
as to why they should. In the event that professional planning
is undertaken, the reason most often cited is to minimize estate
taxes. If and when it becomes clear that minimizing estate taxes
is no longer the driving concern, fewer still will take the time
and initiative to plan.
Practitioners would do well to consider proactively
stepping-up the non-tax aspects and core competencies of their
estate planning offering, including sharpening their skills at
family counseling, asset protection, elder care, income tax
planning (particularly with respect to retirement benefits) and
business succession planning.
Yes, imagine for a moment there's no estate tax. Come on now,
it's easy if you try.
Charlie Douglas, JD, CFP®, AEP® has practiced
in the business, tax, estate and financial planning areas for
over 25 years. He holds a J.D. from Case Western Reserve School
of Law and possesses the Certified Financial Planner® and an
Accredited Estate Planner® designation. As a senior vice
president for a leading global wealth management institution,
Charlie specializes in comprehensive planning solutions and
trust fiduciary services for business owners, high net-worth
individuals and their families. Charlie is a board member of the
National Association of Estate Planners & Councils ("NAEPC") and
is the current editor of the
NAEPC
Journal of Estate & Tax Planning.
This information is provided for discussion purposes only
and is not to be construed as providing legal, tax, investment
or financial planning advice. Please consult all appropriate
advisors prior to undertaking any of the strategies outlined in
this article, many of which may involve complex legal, tax,
investment and financial issues. This communication is not a
Covered Opinion as defined by Circular 230 and is limited to the
Federal tax issues addressed herein. Additional issues may exist
that affect the Federal tax treatment of the transaction. The
communication was not intended or written to be used, and cannot
be used, or relied on, by the taxpayer, to avoid Federal tax
penalties.
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