A person who owns a modest suburban home, has put away money into a 401(k) for years and has several hundred thousand dollars worth of life insurance could end up leaving an estate subject to estate tax. Such persons are hardly in the category of wealth of someone like Bill Gates, Warren Buffett or other multi-billionaires.
There are techniques that we can use in estate planning to enhance the value of estate tax exemptions and to mitigate the impact of estate taxes but a major difficulty and frustration for professionals and clients in this field is the uncertainty. Will the estate tax exemption really drop down to $1 million? Will some new reform be passed that will set it at some higher level? The one thing that is pretty certain now is that there is a distinct tax advantage for heirs and beneficiaries of people who die in 2010 as the beneficiaries of some very wealthy folks like the late New York Yankees owner, George Steinbrenner are finding out. As a recent USA Today article noted, some people who were suffering from terminal illnesses in 2009 had a tax incentive to maintain life support until 2010 began and now with 2010 in its later months, there are terminally ill individuals and their families who may well be considering whether to withdraw life support measures to bring about death before 2010 ends. I will make a prediction that we will see at least one episode on one of the television crime drama shows which involve a homicide intended to bring about a death in 2010 to avoid estate taxation.
So what is happening now? As reported in that same USA Today article, in 2009, the Obama Administration proposed freezing the estate tax at the 2009 levels with a $3.5 million exemption and 45 percent rate on assets exceeding the exemption amount. The House of Representatives approved this proposal but Republicans blocked action in the Senate. Meanwhile, in July of this year, Sen. John Kyl (R-Arizona) and Sen. Blanche Lincoln (D-Arkansas) reintroduced a proposal that would set the estate tax to have a $5 million exemption and a 35 percent tax rate on assets exceeding that exemption amount.
To try to get some historical perspective on this, I found an IRS publication on the history of the estate tax. The estate tax as we know it today goes back to 1916. Back then, there was an exemption amount of $50,000.00 I ran that amount through a CPI calculator and found that adjusted for inflation, $50,000.00 in 1916 would have the purchasing power of $1,001,431.19 in 2010. So initially, it might seem that a $1 million exemption at least would be in line with the original 1916 exemption amount. However, other factors indicate that the reach of the estate tax has expanded significantly. First, in 1916 the top tax rate was only 10 percent whereas in 2011, it will be 55 percent. (It was actually as high as 77 percent from 1941 through 1976.) Perhaps more significantly, the types of assets that are subject to taxation has expanded since 1916 - most notably taxation of life insurance proceeds which many families depend upon to replace the income of a family breadwinner.
The estate tax was originally intended to limit concentration of major concentrations of wealth in the hands of a few powerful families (as well as to provide revenue). Indeed Bill Gates and Warren Buffett, two of the richest men on the planet are outspoken that there should be estate taxation to limit over-concentration of wealth. However, to limit the impact of estate taxation to those on whom it is really intended - the very wealthy, it seems reasonable to have an exemption that is significantly higher than the $1 million that will result from the 2011 automatic reversion. Whether that level should be $3.5 million or $5 million can be debated but it is time for the politicians in Washington to figure out a compromise and get it done.