Estate tax repeal: What now?

• Author: O'Connell, Frank J., Jr.
• Position: Economic Growth and Tax Relief Reconciliation Act of 2001

On June 7, 2001, President Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Clients undoubtedly have heard about the estate tax provisions of the EGTRRA and wondered what estate tax repeal means to them.

Provisions of the EGTRRA

In general, the EGTRRA phases down the maximum estate tax rate from 60% in 2001 to 45% in 2009. In addition, it increases the estate tax exclusion in increments from $675,000 in 2001 to $3.5 million in 2009. In 2010, the estate tax will be repealed. In that same year, a modified carryover-basis system will generally allow a basis step-up for $1.3 million of assets passing from a decedent to any person, and an additional $3 million of assets passing to the decedent's spouse. To further complicate matters, the EGTRRA contains a sunset provision: it does not apply to estates of decedents dying after 2010.

What Will Congress Do?

Absent further legislation, the estate tax will return on Jan. 1, 2011 to a maximum 60% rate and a $1 million exclusion. Because this would result in a repeal for only one year (with carryover basis) and the reinstatement of the tax, estate tax practitioners widely agree that Congress is unlikely to allow the current legislation to continue unaltered.

One possibility is that Congress might permanently repeal the estate tax. However, if a Republican President and Congress could not enact complete repeal in a year with current and projected Federal budget surpluses, complete repeal is unlikely in the future under potentially less favorable conditions.

Another possibility is that Congress might lock in the tax rates and exemptions during one of the phaseout years. One view is that Congress might wait until the last minute and enact legislation in 2009 that locks in the 2009 rates and exemptions. However, if Congress was influenced by a desire to avoid revenue losses for the Federal government, legislation in 2009 would probably be unpalatable to Congress, because this could result in a relatively large net revenue decrease. Specifically, Congress might view the fact that the maximum estate tax rate after 2010 would remain at 45% (instead of increasing to 60% as planned under the EGTRRA) as a revenue decrease. In addition, Congress might view the fact that the estate tax exemption after 2010 would remain at $3.5 million (instead of decreasing to $1 million as planned under the EGTRRA) as a revenue decrease. These large revenue decreases would be offset only by a...