Federal Estate Tax Exemption Continues as Guessing Game

Get ready because estate taxes are about to change. Again. Perhaps dramatically.  

Over the years, federal estate tax exemptions have consistently been inconsistent. In 2001 for example, the exemption was $675,000 – meaning that every dollar more than $675,000 inherited from a non-spouse would be subject to the tax. The exemption steadily increased each year, up to $3.5 million in 2009, and then in 2010 there was no estate tax – the exemption was unlimited. However, there was a catch: the exemption was set to sunset, lowering to $1 million in 2011.

Just days before that was about to happen, Congress stepped in and passed the Tax Relief, Unemployment Insurance Reauthorization, and Jobs Creation Act of 2010, which increased the estate tax exemption to $5 million. This meant that any estate worth less than $5 million would be exempt from the federal estate tax. (At the same time Congress also increased the gift tax exemption, which is the amount someone can gift tax-free over his/her lifetime, and lowered the marginal gift and estate tax rate from 55 percent to 35 percent.)    

Again, there was a catch: the $5 million exemption that is now in effect, will sunset on Dec. 31, 2012. Unless Congress passes a new law, the estate tax exemption will lower to $1 million on Jan. 1, 2013 (and the marginal estate tax rate will increase back to 55 percent).

The last time Congress was faced with an estate tax exemption about to expire – the end of 2010 – it increased the exemption, albeit for only two years. That time, the mid-term elections had passed, and Barack Obama was two years into his presidency.  

This time, while we wait to see what Congress does, congressional elections and the presidential election are fast approaching. Estate taxes will likely be one of many campaign issues, although there has been little discussion about it in Congress to date. And the presidential candidates have made little mention of it either, making a lot of folks nervous that Congress will allow the $5 million exemption to expire, in favor of the $1 million exemption.

The wealthiest few – figuring that Congress won’t extend the $5 million exemption and 35 percent estate tax rate – have already taken advantage and made substantial tax free gifts in order to lower the value of their estate.      

For the other 99.9 percent for whom gifting may not be so wise, things are complicated because nobody knows what Congress will do. If Congress votes to renew the current scheme, then nothing will have changed. On the other hand, if Congress does nothing, and the exemption sunsets to $1 million, a substantial number of inheritances will then become subject to the tax. The other possibility – the more likely scenario – is that Congress compromises and sets the exemption somewhere between $1 million and $5 million. That scenario will affect some estates, but not others. But until that happens, taxpayers are left scratching their heads wondering what it will be—and how to plan for the unknown.