On April 16, the House of Representatives approved H.R. 8, the Death Tax Repeal Permanency Act of 2005. This bill would repeal the Federal estate tax permanently, effective in 2010. (Under current law, the estate tax is scheduled to be eliminated for one year only, as to decedents who die in the year 2010, but the tax is scheduled to be reinstated as to decedents who die in 2011 or later.) Although the Senate has not yet begun active consideration of this bill, this is a good time to examine the potential consequences of eliminating the estate tax - the good, the bad, and the ugly.
The repeal of the estate tax would allow estate planning to be what it should be and not just planning to avoid taxation. The laws are so complex that an estate planning team spends most of its time learning the law, understanding it and then planning on how to use the law to the client's advantage to reduce the amount of taxes paid.
If the estate tax is permanently repealed, the estate planning team could focus on the client's real legacies - what clients really want to pass on to their heirs, monetary and non-monetary. We would be able to consider the non-monetary legacies first and direct the monetary legacies to be consistent with and aid the implementation of the clients' goals. Clients could take the opportunity to fantasize about what they would really like to pass on to their heirs.
Estate planning is currently motivated by taxes. With the estate tax gone we could look at the process and stop and ask our clients if they would still structure their estate plan the same way with all the tax benefits gone. The answer should be yes. Estate planning should enhance some part of our clients' lives or the lives of their heirs.
If the estate tax is repealed the loss of income to charitable organizations will be enormous. The incentive to make charitable donations is highly sensitive to the amount of tax saved. The Congressional Budget Office ("CBO") has found that the estate tax encourages wealthy individuals to donate more money than they would otherwise, since the estate tax liability is reduced through lifetime donations as well as at death.
The CBO estimates that if the estate tax is repealed, the amount of lifetime charitable contributions would be reduced about 6 to 11 percent. In dollar terms, this would amount to reductions of lifetime charitable giving between $11 billion and $21 billion.
The CBO also estimates that the repeal of the estate tax would reduce the percentage of bequests at death by a greater amount. The percentage reduction is predicted to be between 16 and 28 percent. This reduction in bequests would result in loss to charitable organizations of approximately $3 to $4 billion.
If the estate tax is repealed, the total drop in estimated giving for both lifetime gifts and bequests and death would amount to around $13 to $25 billion. As these figures show, the estate tax is a powerful incentive in encouraging wealthy individuals to donate more money to charitable organizations.
Here is an example. If the assets in an estate are above the level where they would be subject to a 47% estate-tax rate (47% is the maximum rate for 2005), a charitable bequest of $100 reduces the tax bill that the estate must pay by $47, since bequests are exempt from taxation. The charitable bequest of $100 then only costs the estate only $43. Without the estate tax, the bequest of $100 would reduce the bequests to other heirs by $100 because there would be no tax savings in making the contribution.
The repeal of the estate tax could actually cost the heirs more in real tax dollars. If the estate tax is repealed it would be replaced by a capital gains tax. Under current law, upon an individual death, the basis of the assets included in the decedent's estate are "stepped up" or made equal to the fair market value of the asset on the date of death. This provision provides significant tax benefits when the heir sells the property at the higher basis thus reducing the amount of tax paid on the heir's individual 1040 return.
If the estate tax is repealed the amount of "step-up" or increase in basis will be limited. The current proposal would limit this amount to $1.3 million for assets held by decedents. A decedent's estate could receive an additional basis adjustment of up to $3 million provided that the assets are left to the surviving spouse. However these "step-up" or basis increases cannot increase the basis of the assets above the value of the assets at the date of death. Therefore, all of the decedent's assets and the surviving spouse's assets will have a basis equal to the lesser of the decedent's (or survivor's) basis or value at death.
The replacement of the estate tax with the capital gains tax could now force most heirs to pay some capital gains tax on their inheritance. The current estate tax is structured so that only the very wealthy will actually pay an estate tax. And right now the capital gains tax is at an all-time low rate. What will happen if the capital gains tax rate is increased?
The current provision in the tax law also provides relief for individuals who have not maintained records of the costs of their assets. The value of an asset for estate tax purposes can now be determined by an appraisal or by reference to published record for stocks and bonds listed on a national exchange. However, the repeal of the estate tax would force heirs to determine the original basis of an asset they sell. This could lead to major complications in determining the original value of an asset that has been acquired by a decedent over time. Examples of assets that could cause a major problem in determining the values are stamp or coin collections, or even stock certificates which have been acquired with dividend reinvestments.
The Law Offices of Marc J. Lane would be happy to discuss your unique situation with you, and help you design the best estate plan to meet your special needs.
Jo Bechtel, CSEP, CPA, is associated with The Law Offices of Marc J. Lane, a Professional Corporation. Ms. Bechtel is a graduate of Keller Graduate School of Management (M.B.A.) and De Paul University (B.S.).
The Lane Report is a publication of The Law Offices of Marc J. Lane, a Professional Corporation. We attempt to highlight and discuss areas of general interest that may result in planning opportunities. Nothing contained in The Lane Report should be construed as legal advice or a legal opinion. Consultation with a professional is recommended before implementing any of the ideas discussed herein. Copyright © 2007 by The Law Offices of Marc J. Lane, A Professional Corporation. Reproduction, in whole or in part, is forbidden without prior written permission.