May 26, 2010

The following is an estate tax reform update, various possible outcomes and several interpretations from estate planning and tax attorneys throughout the United States. We thought we’d keep you up to date and share some of the interesting comments:

1. Late last year (2009) the House passed HR 4154 which permanently extended the $3.5 million dollar exemption (this is per person) for estates from estate tax. For a couple this meant they could
shelter $7,000,000. [Note: In 2011 the exemption will return to $1,000,000 per person unless Congress changes the law. This change is what we are talking about.] Furthermore, the House
legislation does away with the carry over basis rules which are being applied for decedents dying in 2010 and which have created such a nightmare in the administration of estates.

2. The Senate is trying to pass legislation itself, but has not been able to do so. This is where the hangup is at this time. If it does pass any reform then any Senate bill will need to be reconciled with the 2009 House bill before a compromise bill can be sent to the President for his signature. Any Senate bill will require 60 votes in the Senate to make the reformation permanent.
As of today, it is being reported Senate Finance Committee member Jon Kyl, R-AZ has reached an agreement with Senate Finance Commitee chairman, Max Baucus, D-MT to have the
finance committee propose legislation (in the form of a Senate bill) to allow an exemption of $5 million and an estate tax rate on amounts in excess of this amount at 35%. Many details would
still need to be worked out including whether it would be retroactive to January 1, 2010, whether it will be indexed to inflation, what any phase in might look like, how it would be reconciled with the House bill, portability or a variety of other issues under consideration.

3. There are only 13 “legislative weeks” remaining this year. At the end of August Congress will head out for recess and campaigning. If something is not done by then it is likely there will be no estate reform until perhaps after the elections have been completed.

4. In 2010 Congress passed the “Pay-as-You-Go Law” which requires Congress to find other sources of revenue for losses in revenue from tax cuts. In other words if a permanent repeal of
estate taxes is passed and if the exemption level which is set results in a tax cut being given then revenue must be found elsewhere in the budget to make up for the lost revenue from the estate
tax cut. Under current Pay-as-You-Go parameters Congress could pass a law allowing for the 2009 exemption amounts through 2011. This is a short term solution and not really preferred by
anyone in Congress, although some would argue is a step in the right direction. [Note: Getting a two year reprieve is not of much help to those with potentially taxable estate. It only continues the uncertainty for any client expecting to live beyond 2011.]

5. Senators Kyl (R-Ariz) and Lincoln (D-Ark) are the Senators who are leading the charge in the Senate Finance Committee to get something done. I am not sure how Senator Lincoln fits into
the agreement reached between Senators Baucus and Kyl as indicated above. They are pushing for a $5 million exemption and a rate on estates above this amount of 35%. To get to these
exemption amounts they must find revenue offsets [more on this below], which they may or may not be able to do.

6. So how does Congress get out of this hole and find a solution? There appears to be several options and each will require serious consideration and negotiations, not only amongst the
Senators, but the House and perhaps the office of the President. From the chatter (and my own thoughts) here are the possible solutions:
a) Option #1 Do nothing and let the estate tax exemption fall back to $1,000,000 starting in 2011. This does not seem like a popular solution in an election year. It would continue to show
Congress cannot work in a bi-partisan fashion to craft a remedy to give certainty to the electorate in planning their estates in an environment where inflation could rise pushing more and more
individuals into the dreaded estate tax zone. Furthermore, it does appear there is a real push to try to get something done as is evidenced by the chatter.
b) Option #2 The Senate could declare the estate tax reform to be an “emergency” and as such it would be exempt from the Pay-as-You-Go rules. Congress has only known about this possibility
if they failed to act for 10 years and now arguing it is an emergency would seem a bit ingenuous and likely to raise further furor at the ballot box.
c) Option #3 Congress could find offsets for the lost revenue. Again, this could be politically unpalatable if the offsets come from programs which do not impact the wealthy. This would be
reverse Robin Hood where taking from the poor and giving to the wealthy may not set well at the ballot box. To find offsets which impact only the wealthy Congress could (1) look to the
elimination or reduction in the use of the Grantor Retained Annuity Trusts; (2) eliminate the use of “discounts”; (3) eliminate the state death tax credit; (4) eliminate the use of Qualified Personal Residence Trusts and (5) allow for the use of something called a Prepayment Trust, which would allow you to prepay your estate tax. On the Prepayment Trust you can draw a parallel to the Roth Conversion idea where you give the IRS your money now to avoid later taxation. Some argue the offsets need to be found only for the amount of any lost revenue above the
amount in the House bill which made the repeal permanent at the $3.5 million dollar level. If this is the case it is possible the offsets needed may not be as great. It also leaves open the option of simply staying with the $3.5 exemption amount.
d) Option #4 Congress could amend the Pay-as-You-Go rules to provide for an exception for estate tax reform. Try to sell that one back home! Furthermore, the Blue Dog Coalition in the
House would likely not support this approach.
e) Option #5 If Congress wanted to they could just pass the new legislation and worry about making up the deficit in revenue by cutting other programs later in the year.
There does not appear to be any discussion about the concept of “portability” in the discussions with the Senate staffers. Portability would have simplified the planning process by allowing a
surviving spouse to have an exemption of twice the exemption amount ($7 million if the exemption were $3.5 million per person). This would make planning for when the first spouse
much easier and would do away with the need to create the “Bypass Trust.” So stay tuned. These are exciting times. If the current chatter amongst our colleagues and the
Congressional staffers and quotes by key members of the Senate are any indication, estate reform could be coming in the next months. We will try to keep you up to date. If you have questions in
the meantime then come in and set a time to visit.

Source: Baird D. Brown, Attorney at Law, Grand Junction, CO – 5/18/10.