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CRS study examines estate tax options
A Congressional Research Service (CRS) study examines various estate tax options that Congress may consider in addressing the uncertain state of affairs resulting from the fact that the estate tax currently doesn't apply to estates of decedents dying in 2010 but is scheduled to come back in harsher terms for those dying after 2010.
Background. The Economic Growth and Tax Relief Act of 2001 (EGTRRA, P.L. 107-16) provided for a gradual reduction and elimination of the estate tax. Under EGTRRA, the estate tax exemption rose from $675,000 in 2001 to $3.5 million in 2009, and the rate fell from 55% to 45%. In 2010, the estate tax was eliminated. Estate tax repeal for 2010 includes changes to the income tax basis rules for property acquired from a decedent. However, the estate tax changes will sunset in 2011; the exemption will become $1 million (as scheduled in pre-EGTRRA law) and the tax rate will return to 55%. The carryover basis provision effective in 2010 would be eliminated (so that heirs will not be taxed on gain accumulated during the decedent's life when they inherit assets). For additional details and concerns triggered by repeal, see articles in Federal Taxes Weekly Alert 01/07/2010, 02/11/2010, and 03/04/2010.
Estate tax will continue. The CRS study notes that most agree that the 2010 provisions will not be continued, and, indeed, may be repealed retroactively. President Obama proposed a permanent extension of the 2009 rules (a $3.5 million exemption and a 45% tax rate), and the House of Representatives provided for that permanent extension on Dec. 3, 2009 (H.R. 4154, see Federal Taxes Weekly Alert 01/07/2010). The Senate Democratic leadership has championed a plan to retroactively reinstate the 2009 rules for 2010 and beyond. Senate Minority Leader McConnell proposed an alternative of a 35% tax rate and a $5 million exemption. Senators Lincoln and Kyl offered a similar proposal for a $5 million exemption and a 35% rate, with the ability of the surviving spouse to inherit any unused exemption of the decedent. Others have argued for a permanent estate tax repeal.
The CRS study notes that certain structural reforms might be considered. They include inheritance of spousal exemptions, and some reforms directed at abuses. Other provisions in President Obama's budget .....
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CRS study examines estate tax options (continued) ... Other provisions ...include restricting discounts for estates left to family partnerships and conforming fair market value for purposes of the estate tax and future capital gains realizations for heirs.
Options for revision. According to the CRS study, the principal components of any policy that continues the estate tax are the amount of the exemption and the tax rate. Absent a change in the statute, the estate tax will revert to an exemption of $1 million. The two most common levels exemption levels being considered are $3.5 million and $5 million. The level of the exemption affects not only the revenue but the number of estates that are subject to the tax.
The second principal component of a continued estate tax is the rate, which will return to 55% absent legislative change. The two most common rates being considered are 45% and 35%. However, some proposals would apply the capital gains tax rate (currently 15% but scheduled to go to 20% in 2011) or some multiple of it. Another issue is whether to index the exemption for inflation. Over time, as prices rise, a fixed exemption causes more estates to be subject to tax. Without indexing, Congress may return from time to time to reconsider the exemption.
A final issue is the potential carryforward of an unused estate tax exemption to the surviving spouse. Since bequests to the spouse are excluded from the estate, the couple together can have a larger total exemption if the first spouse to die leaves assets to the children or other heirs large enough to absorb his or her estate exemption. This action will reduce the size of the estate subject to tax when the second spouse dies. There are reasons, however, that the taxpayer may prefer to leave more assets to a spouse. A proposed change would permit the second spouse to inherit any unused exemption and add it to his or her own future exemption.
The CRS study notes that the estate tax has never affected more than a small fraction of decedents. If the law reverts to the $1 million exemption, less than 2% of decedents would pay an estate tax. Restoring the $3.5 million exemption leads to a quarter of 1% of decedents paying the tax. Moving to a $5 million exemption reduces the share to 0.14%.
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