Next Battle on the 'Cliff's' Edge: Estate Taxes

Sam Bassett | Riser | Getty Images

The fight over taxing the wealthy has largely focused on income taxes. But there's another tax that's becoming the source of growing dispute in Washington: the estate tax.

The estate-tax rate is currently 35 percent on estates valued at $5 million or more. But if the United States goes over the fiscal cliff, the rate jumps to 55 percent. More importantly, the exemption drops from $5 million to $1 million – ensnaring tens of thousands of additional taxpayers in the tax.

So far, there is little agreement on a compromise. While Democrats and Republicans remain predictably far apart, division within the Democratic Party over the estate tax is also clouding any solution.

Hanging in the balance is hundreds of billions of dollars in tax revenue over the next 10 years, and the fates of some of America's largest fortunes. (Read more: Wealthy Dump Assets Amid 'Cliff' Worries)

It also has large symbolic value. The tax has been labeled "the death tax" by conservatives who say it hurts farms and small businesses. The left, meanwhile, says the tax is needed to prevent family fortunes in America from becoming too large and creating powerful dynasties.

The estate tax was among the largest but least noticed components of the Bush tax cuts. The rate has fallen steadily since 2001 – from 55 percent to its current rate of 35 percent. In 2010, there was no estate tax, leading to criticism that families of several billionaires inherited fortunes without paying any tax at all.

Many Republicans say the estate tax should be banned altogether. But some have said that if the tax is to remain, it should be at the current levels of 35 percent on a $5 million exemption.

President Obama has proposed setting the estate tax rate at 45 percent -- above current rates but below the rate in 2001. He supports an exemption of $3.5 million – also a mid-point between today's level and the 2001 exemption.

Some Democrats, however, have broken ranks with the president. Senators Max Baucus of Montana, Mary Landrieu of Louisiana and Mark Pryor of Arkansas, all Democrates, are siding with Republicans in proposing that the current rates be made permanent. They say the hikes would hurt farmers.

According to the non-partisan Tax Policy Center, the estate tax raised $10.6 billion in revenue in 2012 and is expected to raise $12 billion this year. (Read more: Wealthy Work to Beat the 'Dividend Cliff')

If the current rates are extended, estate taxes will raise $13.5 billion in 2013, and $161 billion by 2021. If the estate tax expires, and reverts to the levels before the Bush tax cuts, the estate tax would raise $531 billion by 2021.

Under Obama's plan, with a 35 percent rate and $3.5 million exemption, the estate tax would raise $258 billion by 2021.

In an interview with the Great Falls Tribune, Sen. Baucus said that "those tax cuts, which help farmers and ranchers pass their agriculture assets on to their children, expire at the end of 2012. "

Tax data suggests that farmers account for a very small amount of estate taxes paid. According to the Tax Policy Center, of the 3,270 taxpayers paying an estate tax in 2011, fewer than 50 were small farms and businesses, representing just over one percent of total estate taxes paid.

The top one percent of earners, by contrast, paid nearly 80 percent of the estate tax last year. The top 0.1 percent paid nearly half.