Avoiding the Fiscal Cliff – Estate Taxes

With the Senate tax bill passing the House, it is expected that it will be signed into law. It does not appear that there was a lot of focus on the estate tax. Considering that most tax revenue is generated by the income tax, it is not surprising. Estate planners will at least have some certainty going forward regarding the estate and gift taxes. I was pleasantly surprised to see that the exemption amount will remain at five million dollars ($5,000,000) per person. This means that a married couple with proper planning can pass up to ten million dollars ($10,000,000) estate tax-free. Furthermore, the exemption amount is indexed for inflation. The exemption amount as adjusted for inflation was $5,120,000 in 2012 and should be just slightly higher in 2013. If Congress did not address the estate tax exemption amount it would have returned back to one million dollars ($1,000,000).

 
The other important component of the estate tax is the maximum tax rate. The highest tax rate for 2013 will be 40%. While this is an increase from 35% for 2012, it would have been raised back up to 55% had Congress not acted.

Use It or (Possibly) Lose It

Currently, the federal gift tax exclusion amount is $5,000,000. If Congress does nothing, which we know from recent years is a real possibility, the law sunsets on December 31, 2012 and the exclusion amount will drop to $1,000,000. If Congress does act, it is possible (maybe even likely) that the exclusion amount will be lower than $5,000,000. This means that the wealthy may have less than two years to gift significant wealth tax-free.

Bye Ohio, It’s Been Nice Knowing You

While the status of the federal estate tax legislation garners much attention these days, Ohio’s current estate tax system deserves some focus. In about a month and a half, the federal estate tax exemption amount rises to $3,500,000. While that is great news for many people, Ohioans still get hit with one of the highest (if not the highest) estate taxes. Ohio’s exemption amount is just $338,333. The maximum tax rate (on estates over $500,000) is 7%. Is it any wonder that Ohioans are converting their vacation homes in Florida to permanent residences? Florida has no estate tax. Throw in the fact that Florida has no income tax and it becomes clear that it is fiscally prudent to make that move. Perhaps the best evidence of this migratory effect is that of the late Senator Howard Metzenbaum. Here is the story that The Wall Street Journal ran on Metzenbaum.

Senator Snowbird, RIP Wall Street Journal, May 3, 2008; Page A10
Former Ohio Senator Howard Metzenbaum, who died in March at age 90, was an ultraliberal as a politician but also a savvy and very rich businessman. Before going to Washington in 1976, he had made a fortune on parking lots.
As a three-term Democrat, he made his reputation in Washington by attacking big business and fighting anything that even hinted of deregulation. His attacks against Clarence Thomas in 1991 prompted a famous retort from the future Supreme Court Justice: "God is my judge, Mr. Metzenbaum, not you."
But we come today not to judge the late Senator, only to praise him for one last act of personal financial acumen. Though a lifelong Ohioan, the Senator moved to Florida in 2002, according to a declaration of domicile filed with the Broward County Clerk's office in 2003. In doing so, he avoided paying his home state's income tax (top rate: 6.55%).
More important as he neared the end of his life, the former Senator also saved his family from paying Ohio's death tax, which features one of the highest state rates (7%) and lowest asset thresholds - $338,333 - in the country. Florida famously has no income or estate tax, which is one reason other than the climate that it is home to so many northern-born retirees.Howard Metzenbaum thus denied the state in which he lived most of his life a parting financial gift. But he has at least provided the rest of us with a teaching moment in tax policy. If a liberal lion like Metzenbaum is willing to relocate late in life to avoid his state's death tax, maybe living politicians in Ohio will better understand how their confiscatory tax laws are driving its citizens to warmer climes.

Optimism Wanes Among Proponents of Estate Tax Repeal

As a result of the Congressional compromise known as the 2001 Tax Relief Act, the applicable exclusion amount (the amount exempt from federal estate tax) has been increasing and the maximum tax rate has been decreasing. The current exemption amount is $2,000,000 and will rise to $3,500,000 with dates of death on or after January 1, 2009. The $3,500,000 exemption amount is only for 2009, and in 2010 the tax is scheduled to be repealed (but only for that year). If nothing happens legislatively before the end of 2010, the Act has a Sunset Provision and we will revert back to the $1,000,000 exemption amount. No doubt the proponents of estate tax repeal felt that the repeal in 2010 should and could be made permanent. Opponents, and perhaps realists, believed that estate tax would not be repealed and that Congress would enact a more permanent exemption amount before 2010.

While the Tax Relief Act was still young, there was optimism that the estate tax would be repealed or the exemption amount raised to tax only the very wealthy, e.g., $10,000,000 and up. There is no longer serious talk of repealing the federal estate tax. The question is now when will Congress act and what will the exemption amount likely be.

When will Congress act? Congress will almost certainly be forced to address the repeal issue before the one year repeal scheduled for 2010. Based upon the lack of urgency, Congress has not addressed this issue to date, and may not until late in 2009. It has also been suggested by some people following this legislation, including Professor Jeffrey N. Pennell, that Congress could wait until 2010 with a retroactive effective date to the beginning of that year.

What will the exemption amount likely be? No one knows…yet. As stated above, no one is realistically talking repeal and the speculation is that it will be more in the $3,000,000 to $5,000,000 range. The Kiplinger Letter now forecasts that Congress will freeze the exemption amount at $3,500,000. [The Kiplinger Letter, Vol. 85, No. 45].
Another important aspect of the estate tax law is the maximum tax rate. The maximum tax rate for the federal estate tax is 45%. Much like with the exemption amount, there was optimism early on that the rate would drop significantly. The optimism is now waning, and The Kiplinger Letter now predicts that Congress will freeze the maximum tax rate at 45%.