Estate Tax Is Expiring, but Death Won’t Last

A Congressional tax standoff has opened a window of opportunity for wealthy Americans determined to avoid paying up post-mortem.

With lawmakers unable to agree on a year-end fix for a quirk in the Bush-era tax cuts, the federal estate tax is set to be repealed for one year as of Jan. 1, meaning that those who suffer a timely death could escape the usual certainty of taxes.

“If you are at the checkout counter, you might want to expedite things,” said Representative Richard E. Neal, the Massachusetts Democrat who heads the House subcommittee on taxation.

While the tax is about to expire, it probably should not be buried just yet.

Democrats are vowing to resurrect it as soon as Congress returns in 2010. Even its most ardent foes acknowledge that some accommodation will have to be reached because the tax is now scheduled to rise from the grave, zombielike, with even more reach in 2011.

“We understand we are not going to be able to keep total repeal in place permanently,” said Dick Patten, president of the American Family Business Institute, an advocacy group that opposes the estate tax. “By the time we reach the end of next year, we know we have to come with a compromise solution that is advantageous to the survival of family businesses.”

For now, he and the backers of his group are celebrating as the countdown clock at NoDeathTax.org ticks down to zero. But not everyone is happy. The extremely jumbled tax situation has members of Congress at odds, estate planners facing questions from their clients and, perhaps, the heads of some wealthy families wondering if relatives gathered for the holidays truly wish them a happy and healthy new year.

“It has the potential for chaos,” said Chuck Marr, director of federal tax policy at the Center on Budget and Policy Priorities.

The situation dates to 2001 when Republicans, with President George W. Bush newly ensconced in the White House, sought to realize their goal of eliminating a tax on assets being passed on to heirs. The tax became an iconic issue among Republicans who labeled it the death tax and rallied around its repeal in the mid-1990s during their push to win control of Congress.

Backers of the tax cuts wanted it eliminated altogether. But because that would have proved too costly, Congress instead devised a convoluted scheme that gradually raised the value of estates exempt from the tax and reduced the tax rate to the point — for the next two weeks — that an individual estate valued at $3.5 million or more is taxed at the rate of 45 percent. (This year, the tax will bring in an estimated $25 billion).

At the beginning of the new year, that tax is eliminated entirely, only to be restored in 2011 at a rate of 55 percent on estates of $1 million or more — essentially the law in effect before the 2001 change.

At the time, Republicans assumed they would simply fix the flaws well before 2009 ever arrived, presumably through a full repeal of the estate tax. But the political pendulum swung, bringing to power Democrats who were highly resistant to rescinding the tax, a move that many of them believed would be too generous to the nation’s most affluent.

As this year drew to a close, Democrats scrambled unsuccessfully to find an alternative to the wild swings in taxation. But they failed to persuade Republicans to agree to extend the current law, at least until a better approach could be devised.

There is yet another wrinkle. When they scheduled the demise of the estate tax for 2009, the authors of the 2001 tax measure replaced it with a capital gains tax of 15 percent on inherited property that is later sold.

The threshold for being subject to those taxes is set lower, with the first $1.3 million in capital gains exempted for general heirs and $3 million for spouses. Democrats argue that thousands of estates that would not have been subject to taxes under the current law could get hit in 2010 even as those at the higher end of inheritance scale escape the 45 percent tax bite.

“If you are rich, celebrate,” said Senator Harry Reid, Democrat of Nevada and the majority leader. “If you are not, you should be afraid.”

Republicans note that the capital gains tax will be levied only if heirs sell the assets, providing incentive for families to hold on to their farms and businesses.

“As between paying 45 percent and 15 percent, I think it is pretty clear what most small business folks and farmers would like to do,” said Senator Jon Kyl, Republican of Arizona and a longtime foe of the estate tax.

Democrats hope to make the situation moot by restoring the current tax and making it retroactive to Jan. 1. Republicans would like to negotiate a new tax structure, perhaps taxing eligible estates at the 15 percent capital gains rate.

Either way, one thing does seem certain: the struggle over the death tax is not likely to pass on anytime soon.