Things to Consider With the Proposed Repeal of the Death Tax

By Frank S. Macgill, published on February 18, 2011, in Savannah Morning News.

What exactly is the death tax and why is it so unpopular? The term “death tax” generally refers to the federal estate and gift tax, which taxes gifts and estates at rates beginning at 37 percent and climbing to 55 percent. The first $675,000 in assets is sheltered from taxation by the “unified estate and gift tax credit,” commonly referred to as the “unified credit amount.” It is scheduled to increase to $1 million by 2006 under current law. With proper estate planning, a married couple can shelter up to $1.35 million in assets ($2 million in 2006) from the death tax.

While the unified credit amount is high enough to shelter most estates, many people are still subject to the death tax after taking into account all assets in the taxable estate, including retirement plan accounts and IRA’s, life insurance proceeds, real estate, and equity interests in small businesses and family farms (which may have a very high value but generally are not liquid).
Furthermore, the net effect of the death tax upon the estate of a farmer or small business owner, and upon the farm or business itself, can be devastating. The estate tax is due nine months after the date of death, but in certain instances, the tax can be paid over a number of years, with interest. Nevertheless, there is rarely sufficient liquidity or cash flow to pay the estate tax on schedule, so many farms and small businesses must be sold under less than optimal circumstances.

The death tax has been a constant part of the federal tax system since 1916, and until three years ago its repeal was something few thought possible. However, in August, Congress sent President Clinton a bill that called for the phase-out and repeal of the death tax over nine years. This bill received broad bipartisan support in Congress, but it was vetoed by President Clinton. President Bush now has made his own proposal, set forth in a bill co-sponsored by Sens. Phil Gramm, R-Texas, and Zell Miller, D-Ga., which phases out and repeals the death tax by Jan. 1, 2009.

Despite the growing unpopularity of the death tax, recent developments have placed its eventual repeal in some doubt. With the slowing economy has come increased pressure upon Congress to make individual income tax rate cuts retroactive to January 1, 2001, and to address first those tax cut measures which immediately put money in the public’s pockets (and the death tax repeal is not such a measure). Also, Democrats and Republicans appear to be growing farther apart on tax cuts, with Democrats calling for much smaller cuts, and Republicans supporting even greater ones.

Nonetheless, there appears to be ample support in Congress for immediate relief to small business owners and farmers. With that in mind, here are some possible compromise reform measures that could be passed:

(1) An increase of the unified credit amount from $675,000 to $2.5 million or $5 million.

(2) An across-the-board 20 percent reduction in estate tax rates.

(3) The adoption of a new credit or exemption for small business and family farm assets.

(4) A transformation of the unified credit amount to a unified exemption amount, which would remove such assets from the highest tax brackets, rather than the lowest tax brackets.

So what will the end result be? We probably won’t know before August. Meanwhile, you should remember that any eventual repeal measure most likely will be phased in over seven or more years, and estate planning documents should be flexible enough to provide for an alternate distribution scheme in the event of such repeal (and you, not Uncle Sam, would dictate the terms of such a distribution scheme).

Moreover, just because the death tax in its current form may go away, it doesn’t necessarily mean that it will stay gone forever. As the baby boom generation grows older and dies, some economists estimate that up to $136 trillion in private wealth will be transferred by gift or bequest over the next 25 years. This could prove to be a plum too tempting to avoid picking for a future Congress and President faced with a budget crisis. However, even if they were to bring back all or a portion of the death tax, irrevocable trusts already in existence may be “grandfathered” in at no tax.

Therefore, in light of all these considerations, the smartest move may be to adopt an estate plan that, in the event of the death tax repeal, provides for the transfer of assets to one or more trusts that would continue in existence for succeeding generations (for the maximum period allowable by law) in a manner that would not trigger the death tax. By adopting such a plan now, you potentially could lock into place a tax-free estate plan for your family for many, many years to come.

The views expressed in this article are solely those of the authors. This article is intended for general information purposes only. It is not to be regarded as legal advice. Persons with specific questions should seek advice of counsel.

(This publication was coauthored by David A. Anderson, Esq. and was originally published in the Savannah Morning News on February 18, 2001.)

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Frank S. Macgill is the managing partner at HunterMaclean in Savannah. His practice focuses on trusts and estates, taxation, tax-exempt organizations and corporate law. He can be reached at 912-236-0261 or fmacgill@huntermaclean.com.