Bush Tax Cuts Live On

The Dustbin of History?  When President Obama was re-elected on November 6, 2012 I assumed the Bush Tax Cuts would soon land in the dustbin of history. The President and the Democratic Party blame the Bush Tax Cuts for  many of the things that have gone wrong in the American economy since 2008. All that was required to end the Bush Tax Cuts and reinstate the Clinton era tax increases was to hold fast until January 1, 2013 and it would happen automatically. But a funny thing happened as Americans prepared to skid off the fiscal cliff – most of the Bush Tax Cuts were made permanent.

Does anyone down there know how to cut a deal? If the Wall Street Journal can be believed, Kentucky Senator Mitch McConnell and Vice President Joe Biden were the authors of the legislation. McConnell reportedly called the Vice President on December 30, after talks with Democratic Leader Harry Reid had broken down. From that point forward, Biden and McConnell cobbled out the deal that ultimately became law. On New Year’s Day, the Senate approved the deal 89 to 8 and the House followed up with its own vote of 257 to 167 in favor. Two days later President Obama, from Hawaii, by “autopen” signed into law the bill that averted the automatic imposition of the Clinton era tax rate increases.

Here is a sample of what was enacted.

A permanent per-person estate tax exemption of $5.25 million, adjusted periodically for inflation. That means a married couple can pass more than $10.5 million to the next generation free of estate tax. Unless a future President and a future Congress can agree on a change, I could practice law for 20 more years, with a reasonably wealthy clientele, and never see another decedent’s estate pay estate tax.

A permanent per-person gift tax exemption of $5.25 million, adjusted periodically for inflation. The estate tax exemption and gift tax exemption are now “unified.” You can use your entire $5.25 million exemption either during your life or at your death.

Portability is now permanent.  First introduced in 2011, it is a technique available to married couples to reduce estate taxes. It allows the surviving spouse to add the unused estate tax exemption of a deceased spouse to the surviving spouse’s exemption. This is accomplished by filing a federal estate tax return on IRS Form 706 for the estate of the deceased spouse and making the election provided on that return. This means the end of the use of by-pass trust planning for most married couples of modest weath. 

Marginal income tax rates for those above the $450,000 (married) or $400,000 (single) threshold will shoot up to the Clinton era 39.6% rate. For everyone else, the Bush rates apply.

Capital gains and dividends will be taxed at 20 percent for those with income above the $450,000/$400,000 threshold. The Bush tax rates will remain at 15 percent for everyone else.

Permanent?  I’m reminded of Inigo Montoya. “You keep using that word. I do not think it means what you think it means.”  While the new legislation brings a measure of certainty to estate planning that has not existed for several years, it is permanent only in the sense it will not automatically expire. There is nothing to prevent a future Congress and a future President from changes in the federal tax laws. In fact, few things are more certain.

Federal Estate Tax Awakens From Lengthy Coma

Mr. Federal Estate Tax, who had slipped into a coma on New Years’ Day 2010, came out of his year-long stupor on December 17, 2010, much to the surprise of his friends and adversaries. “The reports of my death have been greatly exaggerated,” he declared in a prepared statement released shortly after his awakening. His medical team cautioned that he would remain in a weakened state for a considerable period of time.

His many admirers hailed his recovery and predicted he would regain his old vigor by the end of 2012. His many detractors expressed confidence that he would never again have the strength to strike terror into the hearts of American taxpayers.

His twin brother Mr. Income Tax, and his much younger sibling Mr. Gift Tax, left their brother’s bedside without issuing any statements. They seemed relieved that their year long vigil had ended. Members of the Tax Family have long been viewed as immortal. Many speculated that if Federal Estate Tax could die, the lives of other family members could also be at risk.

So much for my attempt at Explanation-through-Anthropomorphism. Here’s a more straightforward description of the estate tax and gift tax legislation that passed in mid-December.

Background. Prior to Election Day, Democrats who wanted to raise income tax rates and reinstate the estate tax seemed to hold a winning hand. If Congress did nothing, the Bush Tax Cuts would expire on the last day of 2010, and the tax laws that were in effect on January 1, 2001 would be reinstated automatically. In particular, the federal estate tax, which had been repealed for calendar year 2010, would be back with a maximum rate of 55% and a per person exemption of only $1 million.

But elections matter. The Republicans captured the House of Representatives on Election Day, and within 24 hours, President Obama’s key domestic advisor signaled his willingness to accept a temporary across-the-board extension of the Bush Tax Cuts. On December 17, the President did just that, signing into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010. Paul Gigot, editor of the Wall Street Journal, was one of many conservatives to engage in a moment of triumphalism, crowing how he loved the symbolism of two Democratic presidents endorsing the heretofore hated Bush Tax Cuts.

Key Changes in Estate Tax and Gift Tax Laws. The Temporary Estate Tax Relief provisions found in Title III are of the most interest to me, as an estate planning and estate administration attorney. Here are the most significant changes in the estate and gift tax laws.

1. Federal Estate Tax Reinstated. The federal estate tax has been reinstated. The reinstatement is retroactive to January 1, 2010.

2. Per Person Exemption Increased. The per person exemption from the estate tax is raised to $5.0 million. It was $3.5 million per person in 2009. It was 1.0 million in 2001.

3. Estate Tax Rates. The maximum tax rate on an estate in excess of the exemption is 35%. In 2009, the maximum estate tax rate was 45%. It was 55% in 2001.

4. Stepped Up Basis Rules Reinstated. Carryover basis is repealed for 2010. Click here for an explanation of these rules. Instead, the assets in the estates of decedents who died in 2010 are entitled to a stepped-up tax basis under the rules in effect since the early 1980′s.

5. Executor Can Elect Estate Tax Repeal for Those Dying in 2010. For the estate of decedents who died in 2010, an executor may elect out of the estate tax and instead be governed by the rules that had been in effect throughout 2010, prior to December 17, 2010. In those cases, there will be no estate tax. However, those estates will not be entitled to a stepped-up tax basis for appreciated assets, but instead will be governed by the rules of carryover basis. So, the estates of wealthy men and women who died in 2010 will forever escape estate tax.

6. Changes in Gift Tax Begin in 2011. The gift tax rules for 2010 are not changed. The gift tax exemption remains at $1 million and the gift tax rates on gifts not shielded by the exemption remains at 35%. However, the gift tax rules change dramatically in 2011. The gift tax exemption will increased to $5 million per person. Thus for the first time since 2004, the estate tax exemption and the gift tax exemption will be “unified.” Beginning in 2011, a person can use up all or any portion of his $5 million exemption during his lifetime or at his death.

7. Portability. The new law allows for the “portability” of the unified credit between spouses. Starting in 2011, a widow or widower can add the unused estate tax exemption of his or her deceased spouse to his or her own exemption. I plan to write more on portability in a future post, but my initial thought is that most married couples will still want to create by-pass trusts in their estate plans to preserve the exemption of the first spouse to die. The portability option should only be used as a backstop for spouses who did not do proper planning.

8. These New Rules Are Temporary. One final but important point: all these provisions will expire on December 31, 2012 unless the current Congress passes and the President signs legislation to extend these provisions or make them permanent. And if nothing is done, the tax laws that were in effect on January 1, 2001, would be reinstated automatically. While it would be a travesty for the federal government to allow that to happen, virtually everything that has happened with the estate tax laws in the past few years has caught me by surprise.

So strap yourself in. The next two years promise to be another wild ride.