The Death of the Estate Tax

NB: This article was published on December 21, 2009 and contains information that may be outdated. For current information regarding the estate tax, read: Estate Tax Certainty…For Now.

What is estate tax?

The federal estate tax is a tax imposed on the transfer of a “taxable estate” to a decedent’s heirs and beneficiaries. The “taxable estate” is calculated by deducting funeral costs, debts, and assets transferred to a spouse from the fair market value of all assets, including life insurance, in which the decedent had interest at the time of death.

Although every U.S. citizen is subject to the estate tax, the vast majority will not have to pay any taxes. That’s because a certain amount of a person’s estate is exempt from taxation. In 2009, $3.5 million could be transferred free of federal estate taxes.

Unlike some other states, Texas does not have an estate tax or inheritance tax of its own.

The Economic Growth and Tax Relief Reconciliation Act

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (”EGTRRA” pronounced “egg-terra” or “egg-tra”), which gradually cut tax rates and increased the share of an estate exempt from tax. A maximum tax rate of 50 percent was levied on estates valued over $1 million in 2002. But this year, the maximum tax rate was 45 percent and applied only to estates valued over $3.5 million.

Under EGTRRA, all estate taxes are temporarily repealed for one year starting on January 1, 2010. In other words, those who die between January 1 and December 31 of 2010 will have no federal estate tax liability, regardless of the size of their estate.

But unless Congress passes new legislation, tax rates for 2011 revert to prior law, which exposes estates valued at more than $1 million dollars to a federal tax rate of up to 55 percent. That’s why EGTRRA has been dubbed the “Throw Momma From the Train Act,” since potential heirs have a lot to gain from having wealthy relatives die in 2010.

The future of the estate tax

It was believed that Congress would act this year to extend the current law. But as the end of the year quickly approaches, it now appears that Congress will let the federal estate tax expire.

This has created a lot of uncertainty in the estate planning world. But most experts believe that this repeal will be short-lived, with Congress acting next year to revive the law, possibly retroactively to January 1, 2010. However, the constitutionality of retroactive application will likely be challenged by those with means to do so.

What does this all mean for Texans?

Insurance, retirement accounts, savings, and homes can easily push an estate over the $1 million threshold. Therefore if no new legislation is passed and the estate tax laws currently set for 2011 go into effect, many more Texans will be exposed to federal estate tax liability.

However, if the 2009 exemption levels are maintained as expected, or the exemption amount is raised, the vast majority of Texans will continue to be able to transfer their estates free of federal estate taxes.

The good news is that politicians on both sides of the political spectrum seem to recognize that the estate tax laws set for 2011 is too onerous.

The consensus seems to be that new legislation will at least maintain the 2009 exemption amount and rate. There is also a possibility that the tax rate could be decreased, and the exemption amount could be increased or indexed to account for inflation over time.