As we've discussed before, 2010 is a very strange year for the federal estate tax. Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the estate tax rate decreased and size of an estate which would pay no estate taxes increased until, in 2009, a $3.5 million estate would not pay taxes. And then, this year, in 2010, the estate tax went away altogether -- for just the one year. Due to the way the estate tax repeal was structured, in order to reduce the apparent cost of the repeal, it was set to be repealed and then to spring back in 2011 to the same level it was back in 2001. But for one single year, there is no estate tax. 2010. Nobody really thought that over the course of 8 years Congress would ignore it and let the repeal actually happen. It was widely believed that before the repeal took effect, a new compromise would emerge wherein the estate tax would continue to be imposed in 2010 along with some new level starting in 2011 which was more reasonable than the old rather punitive pre-2001 rules. Folks bounced around levels of $3.5 million, $5 million and even $10 million as the threshold, and tax levels anywhere from 15% to 45%. Instead, we're set to have the threshold return to $1 million and the marginal tax rate at 55%.
Well, the fix never happened. As close as we came to fixing this mess was that on Dec 3, 2009, the House passed a fix which kept the $3.5 million and 45% tax rate (the 2009 levels) in place in 2010 and beyond. While this may not seem as great as having no estate tax in 2010, it's vastly more important that the tax doesn't revert to the old rules. And frankly, keeping the 2009 rules in place in 2010 would have led to much more reasonable continuity. Under EGTRRA, the 2010 rules are not just the repeal of the estate tax, but the new addition of more complex step-up basis allocation decisions to be made. It's just messy.
And now Congress's missed opportunity to fix this will have a very noticeable effect. Recently, for the first time since the tax is repealed, a billionaire died. Dan L. Duncan, a Texan who made his fortune in natural gas pipelines, died with an estate estimated to be worth approximately $9 billion. He left his home and ranch and a few hundred million dollars worth of stock to his wife. But the bulk of his $9 billion was left to his children and grandchildren. And at 45%, the taxes which would have been due on that vast estate would have been billions of dollars.
Now, don't for a second believe that his kids will never pay taxes on all of this. While we don't have any details, presumably the capital gains embedded in that estate are enormous. And as soon as those heirs start to liquidate and spend any of that inheritance, they'll have to pay capital gains taxes on it. The step-up allocation is too small to have a real impact on an estate this size. Had the 2009 rules been in place, the entire estate would have gotten step-up basis, so capital gains taxes in the future would be much lower. Nevertheless, they come out way way ahead as it is not - long term cap-gains taxes only when they sell stuff is much less painful than 45% taxes due sometime in the next year.
And now that Congress has already let half of 2010 go by and some huge estates are now to be subject to the EGTRRA rules for 2010, it's very unlikely that any fix can still be passed with the provisions acting retroactively. Mr. Duncan's got some heirs who have billions of dollars worth of incentive to fight the constitutionality of any such attempted retroactive fix. It looks like we're very likely stuck with at least the current rules for now.
Noting that the US Treasury collected only some $25 billion in total estate taxes in 2008, it's clear that estate taxes are not a huge win for the government. How much money folks spent in order to minimize or avoid those taxes is likely to have been in the billions of dollars as well, between setting up trusts, paying lawyers and doing things like buying insurance policies rather than investing directly in our economy.
Nevertheless, even worse than an estate tax and whatever drag it causes on the economy is the uncertainty we are all forced to deal with right now. Having an estate tax bounce around as it will between 2009, 2010 and 2011, and having the punitive levels of taxation return (55% on estates over $1 million) is unfortunate.
The story about Mr. Duncan's tax-free death is here in the New York Times:
http://www.nytimes.com/2010/06/09/business/09estate.html
My notes about the Dec 3, 2009 attempt to fix this are here: The Estate Tax is Back!