So Congress Finally Passed a Tax Bill

Monday, January 31, 2011

What does it mean for the estate tax?

On December 17, 2010 President Obama signed a new tax bill into law. Much of the fanfare (or vitriol depending on your point of view) centered around the income tax portion of the law. However, the bill also included some long overdue changes to the estate tax.

The Estate Tax for 2011 and 2012
While the law is welcome, and replaces the uncertainty we all lived with in 2010, it only barely does so. For now, the lifetime exemption is set at 5 million dollars, with a 35% tax on every dollar over. That’s a very generous deduction, and rate is actually slightly less than the highest marginal income tax rate.

However, the bill only covers 2011 and 2012. After that, it is unclear what will happen. I think it likely that after this law expires, the rate will go up, and the exemption will come back down.

Why? Well, whatever your philosophy on estate taxation, it is important to understand why the tax exists in the first place. Obviously, it raises money for the federal treasury, although as a percentage of the budget, it is quite small.

There are also social engineering purposes (as there are with all taxes). Estate taxes are used to break up large dynastic family fortunes to, at least in theory, strengthen the middle class. They are also used to encourage gifting, especially charitable gifting. If one has a choice between giving money to the government, or giving it to one’s favorite charity, many choose to create a legacy for themselves by giving to charities.

Having a large exemption and especially having a low rate blunts the effectiveness of the estate tax in achieving these goals. This tax bill was a compromise to achieve detente between our two warring political parties. That will soon change.

What to do about your estate plan then?
Next week, what you can do to stabilize your estate plan in times of uncertainty.