CONGRESSIONAL ABDICATION – THE STATE OF THE ESTATE TAX LAW
In the matter of the federal estate (death) tax, the United States Congress has shown itself to be capricious…even irresponsible. This is not an indictment of either political party; rather it is a very lamentable state of affairs brought about by arrogance and intransigence on both sides of the isle. The failure of Congress to enact a revised and definitive estate tax law in 2009 has resulted in an atmosphere of greater uncertainty and risk, potentially exposing clients to unanticipated effects. To truly appreciate the calamity of our current situation, let me first present a little history.
Soon after President George W. Bush was elected in 2000, Congress began working on a bill to revoke the estate tax, an effort that appealed to my particular philosophical perspective. The estate tax is a tax that applies to everything a person domiciled in the U.S. owns…cars, house, real estate, oil and gas interests, cash, stocks, retirement plans, life insurance, art collections, furnishings and yes, even jewelry, fishing rods and gun collections. Generally speaking, the assets in an estate are acquired using post tax dollars, meaning that the assets of the estate have already been taxed by the government once. The notable exceptions to this are some retirement accounts, which are still subject to income tax upon distribution. The intent of the estate tax is to charge for the transfer of assets to the next generation. To many, this system of double taxation (income tax during life and a transfer tax all over again at death) seemed unfair. So, with the support of the President, Congress set in motion a phase-out of the estate tax. The repeal worked by gradually increasing the size of estates exempt from the estate tax, starting with estates valued at $1,250,000. Prior to the passage of the legislation, the exemption level was $1,000,000 and the maximum tax rate, levied on estates valued over $3,000,000, was 55%.
By 2009, the exemption had increased to $3,500,000, after which the estate tax was due to expire altogether in 2010. The problem was that the plan was too ambitious to pass as it was originally intended and true to any major legislative initiative, the law became saddled with a variety of provisions that allowed the legislation to be reevaluated in the future. Many of us planners realized that the voting public would never allow the estate tax to go away completely. Clearly, the exemption level needed to be raised to the point that an average family wouldn’t be caught in the estate tax wringer, but most of us could foresee a point at which Congress would need more revenue than the income tax could provide. Taxing wealthy, dead people is a temptation that’s just too easy for many in Congress to pass up. Well, a provision in the law, referred to as “the Sunset Provision”, made resurrecting the estate tax easy for those in Congress who were philosophically opposed to the estate tax repeal. While the current legislation provides for the complete repeal of the estate tax in 2010, the Sunset Provision reinstates the estate tax in 2011 at 2000 levels. Through mere obstinacy, opponents to the estate tax repeal have the means available to not only accomplish their goal of reinstating the estate tax, but to do so at far higher tax levels than in 2009 and 2010. A mechanism that was originally included to force Congress to reasonably debate, assess, and set estate tax levels has effectively been hijacked by the political fringe to facilitate their tax and spend agendas.
Remember, the $1,000,000 exemption and the 55% maximum estate tax bracket when George W. took office? Short of Congress enacting new legislation, those rules come back on January 1, 2011. The uncertainty resulting from Congress’s inaction is not simply a theoretical annoyance. In some cases, it has forced individuals to make ethical decisions in ways they may not have otherwise made had Congress done their job and enacted new legislation in 2009. A December 30, 2009 Wall Street Journal article titled, “Rich Cling to Life to Beat Tax Man” discussed wealthy Americans hanging on to life until the end of 2009 simply to reach the expiry of the estate tax. The article quotes Prof. Michael Graetz of Columbia University, who worked both at Treasury and for Congress, as calling the lapse of the estate tax as nothing short of “congressional malpractice.” Imagine what the news media will be saying about the concern wealthy Americans and their families will have come December of this year! The infirm rich and their loved ones will be facing life terminating decisions at the end of this year as a rational alternative to paying a confiscatory tax just for living a tick past midnight the evening of December 31st!
The expectation among us in the planning community was that prior to 2010, Congress would pass legislation correcting this unjust and potentially immoral travesty. We had assumed that a compromise would be reached that allowed for a reasonable level of taxes, yet provided a degree of relief for the emerging affluent. In short, I expected Congress to leave us with a $3,500,000 to $5,000,000 exemption and a maximum tax bracket of 45%. And, I had enough faith in our lawmakers to believe that they would get the job done before the tax expired this year.
Well, it didn’t happen. To make matters worse Senator Max Baucus announced from the Senate floor that Congress’s solution was going to be to pass a bill (presumably to freeze the exemption at $3,500,000) before the end of 2010 and make it retroactive to January 1st. I liken that to a college football game where the head official comes into the locker room before the game and announces that the NCAA will come down with some major rule changes by halftime, and then says, “We don’t know what those changes will be for sure, but we will apply those changes retroactive to the first of the game. At halftime, we’ll adjust the score accordingly.”
I find the idea of changing the rules in the middle of the game reprehensible. Congress failed in its duty to resolve this matter when the consequences for inaction were fully known. Only now that the consequences of their inaction have resulted in a material impact to their own agendas, have they found it within themselves to take this matter seriously. The idea that Congress should use a clawback provision to make themselves whole for their own failure to act, when Americans have planned and now died under the existing laws is simultaneously insulting and unjust. Although Congress may feel it has the legal right to pass retroactive tax law, there are many learned attorneys who feel certain that this particular action would be litigated based upon its lack of Constitutional merit. This merely interjects more cost and uncertainty for estates that settle over the next several years.
So, what’s going to happen now? Nobody knows for sure, but I know one thing that’s already happened. A wealthy acquaintance passed away last Friday. I’m sure that his heirs will claim that since he died during a period in which the tax was repealed there is no tax to pay. Executors of other very wealthy Americans who die this year before (and if) Congress takes action will claim the same thing. If Congress follows the course of passing estate tax law retroactively, we can anticipate litigation that will go on in the settlement of large estates for years. This legislative irresponsibility could needlessly cost taxpayers hundreds of millions of dollars in litigation.
If our legislative branch of government does nothing, allowing current law to lapse at the end of the year, the result will be nothing short of moral turpitude. This course will encourage U.S. citizens with estates over $1,000,000 including life insurance who are clinging to life to consider choices that may be morally repugnant to most of us. It will encourage loving family members holding health care powers of attorney to consider similar choices. Clearly, even from Congress’s perspective, that can’t be tenable.
So, here are the three likely outcomes from the current estate tax situation.
1) Congress does nothing. The result will be that we are stuck with a paltry $1,000,000 exemption and a higher tax rate beginning next year. Those wealthy folks who are lucky enough (meant very facetiously) to die this year will owe no federal estate tax.
2) Congress passes a law, which retroactively sets a new (presumably higher) exemption. A higher exemption will be good for many of our clients; however, this result may not be so good for wealthy clients who die this year. This outcome may result in years of uncertainty for beneficiaries as it will likely result in extended court battles as the constitutionality of the ex post facto law is determined.
3) Congress passes legislation that sets a new, higher exemption amount taking effect either as soon as it is signed into law, or at the end of this year. This would result in the most honorable and palatable outcome, short of making the elimination of the tax permanent. Passing legislation in this manner would allow us all to know what the rules of the game are going forward and lawmakers would save themselves the embarrassment of litigating against the deceased.
Again, these are the most likely outcomes, but certainly not the entirety of possibilities. At Wealth Services Alliance® and Probity Advisors, Inc.®, we feel that it is extremely important that we keep our clients informed about the potential changes to the estate tax laws and to be proactive in helping our clients think about how to realign their estates once the new laws take effect. There are a variety of defensive planning techniques that can be implemented in response to any of the three possible scenarios mentioned above. Anyone with a combined estate of over $7,000,000 should plan on meeting with advisors as soon as possible to discuss various settlement distribution considerations. All other clients should plan to meet with advisors later this year or early next year to determine what steps should be taken to eliminate, or at least to minimize the impact of the new estate tax rules, whatever they may be.
We appreciate that uncertainty, when it comes to taxes, is never a good thing. By the same token, staying informed and being adaptive is one’s best defense. While we can’t know the future, there’s one thing that we will promise. We will stay abreast of any changes that are passed, and we stand ready to execute the necessary strategy to keep your estate plan on the right track.
