February 2010 "Federal Estate Tax: Congress Dropped the Ball"

PLANNING FOR WEALTH & SECURITY
By Attorneys Jennifer and Jeff Hawkins

Federal Estate Tax: Congress Dropped the Ball

Congress established the federal estate tax law, which prevails as of this article's publication, in the Economic Growth and Tax Relief Reconciliation Act of 2001. That law provided that the federal estate tax exemption would increase gradually from a $1 million dollar exemption per deceased person in 2001 up to a $3.5 million exemption in 2009. The law completely repealed the estate tax for 2010 but then promised to bring the tax back in 2011 with a mere $1 million dollar exemption. People are now speculating as to what tax Congress will impose on us in 2010 and no one has a clear idea of what to expect.

The federal estate tax is a tax that is imposed on the estate of a deceased person. The tax is designed to collect revenue from the estates of the wealthiest people and spare the tax burden for middle class Americans. The estate tax began to be burdensome in the late 1990's when the land values began their rapid rise and people of modest means found themselves owning assets worth hundreds of thousands of dollars.

An example of how the estate tax hurt people in the late 1990's can be shown by the experience of a hypothetical Vermillion County farmer. This farmer owns 200 acres of farmland in Vermillion County, Indiana, drives a rusty pick-up truck, and keeps his well used farm equipment operating through careful maintenance. The farmer may have a few thousand dollars in the bank, but he expects to spend most of that money on seed, fertilizer, and crop treatment chemicals during the next crop year. Unfortunately for this farmer and his family, when land values rose from $1,000 per acre to $6,000 and $7,000 per acre in that region, a modest farmer ended up owning more than $1 million dollars of farm land without feeling any wealthier or changing his lifestyle in any way. Upon the farmer's death, the estate tax exemption that was previously as low as $600,000 in the early 1990's would not be enough to protect his farm from estate tax. A tax as expensive as 50% would force his children to sell the farm rather than continuing farming in the next generation.

Many estate tax planners expected Congress to modify the estate tax before New Year's Eve of 2009. The tax served as something like a game of "chicken" in which the Democrats and Republicans were driving at breakneck speed toward the New Year's Eve 2009 deadline for changing the law. Most estate planners expected one party or the other to swerve in compromise and make sure a rational estate tax was in place on New Year's Day 2010. Unfortunately, neither party swerved and we ended up with a theoretical repeal of the estate tax in 2010. Although the elimination of the tax may seem wonderful to most people, everyone expects Congress to establish a tax that will still be effective in 2010, but we don’t know what kind of tax it will be and people cannot plan to deal with a tax law that has not yet been written.

Most people expect the estate tax exemption will be at least $1 million dollars when the new law is written. Many people expect the exemption will be closer to the $3.5 million dollar exemption that existed in 2009. Until then, couples with assets worth more than $1 million dollars should speak to their estate planning attorneys about establishing a flexible plan that can help protect against an eventual estate tax law without burdening the couple with excessively complex planning. Once Congress makes a new law, the rest of us can exhale and adjust to the new tax law environment.