The Estate Tax Is Back, But Bite Might Not Be So Bad

The estate tax—gone for 2010 but back in 2011—will have changes that should make it less painful for taxpayers. That's if the current Obama tax cut plan crafted with the GOP becomes law.


The feared provisions—a 55 percent rate on estates valued at more than $1 million for individuals and $2 million for couples—were set for automatic return next year.

Now, as part of theproposedtwo year extension of the Bush tax cuts and the extended unemployment benefits, estate tax payers face a rate of 35 percent with an exemption up to $5 million.

The proposal also lets survivors combine their exemption with that of a spouse who has died, for a total exemption of $10 million—almost guaranteeting they would not pay.

"The best part of this plan is that it's better than the 2011 provisions," says Ryan Ellis, tax policy director at the conservative Americans for Tax Reform. "But it's worse than 2010 when there was no estate tax. Thirty-five percent will become the new normal, I hope, and we can work to get the rate down from there. This will help the economy with keeping more money in the hands of people."

Year-End Investing Tax Tips  -  A CNBC Special Report
Year-End Investing Tax Tips  -  A CNBC Special Report

An estimated 40,000 of the largest estates will skip the estate tax under the new rates, leaving only around 3,500 estates that will owe Uncle Sam. One analyst says that's too much lost tax revenue in a struggling economy.

"The estate tax is a fairly small revenue generator, but it's $300 billion over ten years that's lost with these new rates," says Benjamin Harris, a senior research associate at the Brookings Institute. "Those are taxes that have to be made up elsewhere or we'll have even more deficits. There are also better ways to stimulate the economy, then cutting taxes for the rich."

Estate tax reform for 2011 has been slow to develop. Republicans and Democrats talked compromise on provisions through much of the year and several proposals were made before the November midterm elections—but to no end until now.

"I never thought it would get to this point. It's stunning really, what Congress has failed to do to fix this," says Eric Green, an estate tax attorney and partner at Convicer, Percy & Green, in Glastonbury, Connecticut.

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"The politicians weren't able to get together last year to work out a compromise and I couldn't tell my clients what to do about the rates except to be ready to pay more in 2011 and I'm still not sure what will happen," Greene went on to say.

So what should taxpayers do as Congress rides this tax plan seesaw and the bill remains in limbo?

"If the estate tax is coming back, the planning is pretty much the same, especially for the real high-end incomes," says Christina Mason, an estate and tax attorney and partner at Kelley Drye in New York City. "People can use exemptions and figure the balance to pay the tax. The real problem is for those in the $3-6 million earning range. They don't know whether they will pay or not."

If there's one beneficiary in all this, it's the financial planning sector says John McSpadden, CEO of Mac & Associates, an executive placement firm that focuses on tax and public accounting.

"We've had a 20-30 percent increase in job listings for CPA's and financial planners over the past year," McSpadden explains. "It's directly due to the estate tax uncertainty. People want to shelter as much money as possible and the number of firms looking for professionals has increased accordingly."

Uncertainty remains a problem for the estate tax even with this new compromise. House Democrats intend to tighten the estate tax provisions in the Senate bill prior to the House vote on the package.

"One thing about estate tax and a reason against it, is that it requires a great deal of financial planning, something you don't have to do that for payroll tax," says Harris. "It really needs advance planning for people to feel prepared. Congress should put in a tax code that will last ten years in advance."

"With this being only a two-year plan, it is hard to advise clients for the future," Mason adds. "It's conceivable that if the Republicans win the White House and Congress in 2012, they would repeal the estate tax completely. But there's no guarantee that will happen."

Old As The Nation

Estate taxes are an obvious hot issue. While conservatives decry them, and most taxes, as taking money out of people's hands, billionaire Warren Buffett and other 'high enders' tried stopping the estate tax holiday for this year—saying they were necessary for a strong economy and culture.

Either way, Americans should be used to some sort of inheritance tax by now.

Year-End Investing Tax Tips  -  A CNBC Special Report
Year-End Investing Tax Tips  -  A CNBC Special Report

The first estate tax came in 1797 to help re-arm the U.S. navy and lasted four years. Jump to 1862, during the Civil War, and there was a direct tax on inheritances, but that ended in 1870. Another estate tax popped up in 1898 with a top rate of 15 percent on estates worth more than $1 million to help pay for the Spanish-American War. It ended in 1902.

The 'modern' estate tax started in 1916, with a top rate of 10 percent on estates over $5 million. Rates and caps have changed over the years, once reaching a high rate of 70 percent in 1935. But as part of the Bush tax cut program of 2001, the tax was eliminated in 2010—only scheduled to return next year at the dreaded 2009 rates.

But those having to pay at any rate in 2011 will miss this year's tax reprieve.

"Most people are just more or less resigned to it from what I see," says Mason. "But the people who are more upset are the ones on the cusp. Without the tax being indexed to inflation which is something Congress should do, it leaves a lot of people wondering if they will get hit with it."

The wondering has revived the morbid joke of 2010.

"It's weirdly amusing to say but it's like the late New York Yankee owner George Steinbrenner," says Green. "If you had to pay the estate tax and you had to die, this was the year."