The Federal Estate Tax is Back!
The year 2010 will go down in history as one of the most interesting for estate planning attorneys across the nation. Many estate planning professionals predicted that Congress never would have allowed the repeal of the estate tax at the end of 2009. As January 1, 2011, approached, estate planners waited with bated breath in anticipation for an act of Congress. Just before the year-end and during the lame duck session, President Obama struck an unexpected deal with key Republican leaders. The proposed bill contained generous tax incentives for businesses and individuals alike. Watching the Congressional debates on H.R. 4853, Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010,1 was like watching a playoff game where no one was a big fan of either team. There were expansive benefits, but at a high cost. It should have come as no surprise that something would be done to address the estate tax issue and the other tax issues presented by the 2010 temporary repeal, but few expected that it would be done at the very last possible moment.

Current Baseline Budget
According to the Tax Policy Center, the Obama Administration's budget depended, as part of its baseline, on the permanent extension of the estate tax under parameters that were in effect during 2009.2 The baseline budget assumed at a minimum what the estate tax rate would be and the threshold of the exemption. If the 2001 and 2003 tax cuts had been extended without modification, the estate tax would have been maintained at its 2009 levels, meaning that estates with a net value in excess of the $3.5 million exemption would have been subject to a 45 percent tax rate.3 This assumed that Congress acted and the President acquiesced to extend Bush tax cuts in the same form as they existed prior to December 31, 2009.4 The measure considered at year end allowed a much lower estate tax and a much higher exemption. Doing nothing would have caused the estate tax rate to reset at pre-2001 levels, causing taxes to increase for everyone—an outcome that neither President Obama nor Congress wanted.

2010 Tax Regime
During 2010, because of the estate tax repeal, no estate was taxed, regardless of the size of the estate. While one might think that families of wealthy individuals who died in 2010 enjoyed the tax reprieve for decedents' estates, the estate tax repeal was accompanied by other tax policy changes that affected a decedent's estate. For example: there was no fair market value step-up in basis at the date of death for those inheriting property; capital gains were taxed at less favorable, higher rates; generation-skipping transfer tax increased; and dividends were subject to an increased tax.5 Many speculated that a retroactive tax policy, which was predicted to be in place early in 2010, was still a possibility at year end.6 This was certainly an unwieldy dilemma for estate planners in determining what instruments to employ, what transfers to make, and whether and when to dispose of property.

Other Attempts to Address the Temporary Tax Repeal
Some may think that Congress sat on their hands too long or spent too much time working on health care reform and financial services reform to address the estate tax repeal, but there were numerous attempts to rectify the lapse of the estate tax in both the House and the Senate. Many of these measures were attempted in anticipation of the repeal before the end of 2009. No measure survived the political wrangling that took place in Congress. One internet blog entitled "Future of the Federal Estate Tax"7 captures a summary of many of the attempts by Congress to resolve the tax repeal issue. There were several options, but not one could get passed in both the House and the Senate.

The House passed the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Bill of 2009 (H.R. 4154) to permanently extend the estate tax at 2009 exemption rates.8 For 2010 and later, H.R. 4154 repealed provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) that eliminated the tax on estates, the tax on generation-skipping transfers and the step-up in basis provisions (thus retaining estate and gift tax provisions in effect in 2009).9

The Responsible Estate Tax Act (S. 3533) also would have repealed provisions of EGTRRA that eliminated the tax on estates and generation-skipping transfers and the step-up in basis provisions.10 S. 3533 would have amended the Internal Revenue Code to:

(1) change estate tax brackets for estates over $750,000 and impose a maximum tax rate of 55% on estates over $50 million; (2) require a 10% surtax on estates over $500 million; (3) increase the reduction in valuations of farmland for estate tax purposes to $3 million; (4) increase the maximum estate tax exclusion for contributions of conservation easements to $2 million; (5) require estates' representatives to file information returns and provide valuations and consistent basis information to persons acquiring property from a decedent; (6) set forth estate valuation rules for certain transfers of non-business assets and limit estate tax discounts for certain individuals with minority interests in a business acquired from a decedent; and (7) revise rules for valuing assets in grantor retained annuity trusts to require that the right to receive fixed amounts from an annuity last for a term of not less than 10 years, that such fixed amounts not decrease during the first 10 years of the annuity term, and that the remainder interest have a value greater than zero when transferred.11

The Fair and Simple Tax Act of 2009 (H.R. 99)12 and the Death Tax Repeal Act (H.R. 205)13 would have permanently repealed the estate tax. Permanent repeal was an unlikely scenario. Even if a bill or resolution had survived Congress, it was not anticipated that it would have ever made it past President Obama's desk, at least not before 2012. According to the Joint Committee on Taxation, a permanent repeal would have been expensive.14 It was estimated that between 2008 and 2018, a permanent repeal would reduce revenue by about $670 billion.15 According to the Urban and Brookings Institute Tax Policy Center, a permanent repeal would have been regressive, and the Center believed that the group that would benefit the most is people almost entirely at the top of the income distribution, which would invite massive tax sheltering by the wealthy.16

H.R. 4853, The New "Big Deal"
President Obama's deal with GOP leaders, which was highly contested by more liberal Democrats and Republicans, moved smoothly through the Senate, passing with 81 yes and 19 no votes.17 There was rumor of difficulty in the House of Representatives. Liberal leaders were upset by the more conservative congressional leaders' contradiction—arguing for spending cuts and a lower deficit while pushing forward a bill that would cost $858 billion and provide substantial benefits for very wealthy taxpayers. However, the amended version of H.R. 4853 failed late into the night and the original measure passed un-amended with 277 ayes and 148 nays.18 Under the "Big Deal," the estate tax would be 35% of the taxable estate and the estate tax exemption would increase to a historic high of $5 million through 2012. With this tax regime, it is estimated that only half of the number of estates that were taxed in 2009 would have been taxed if the decedent instead died in 2011 or 2012.19 Key components of the "Big Deal" regarding the estate tax include the following:

Election for 2010 estates. The new measure allows executors of 2010 estates the choice of whether to use 2010 or 2011 tax rules.20

Portability of exemption. A surviving spouse will be permitted to use any unused portion of his or her most recently-deceased spouse's $5 million exemption.21

Gift and generation-skipping tax. The measure unifies the estate, gift and generation-skipping taxes, with one $5 million per-individual exemption for all three.22 The measure makes no changes to the $13,000 annual gift-tax exclusion.23

Extension of Bush tax cuts. The measure extends the tax relief enacted in 2001, 2003 and 2009. This includes allowing the fair market value step-up in basis at the decedent's death for those inheriting property, taxation of capital gains at more favorable lower rates, and decreased tax on dividends.24

Was the "Big Deal" the Best Deal?
One can only wonder if the "Big Deal" was the best deal that the President could have reached. What leverage might President Obama have forfeited by agreeing to this deal when he did? Political pundits will likely discuss this issue during the election season. What might have happened if Congress did not pass the deal? Would it have mattered if the deal did not pass at the end of 2010? The newly elected Republican-controlled House of Representatives likely would have worked hard to pass an estate tax fix retroactively to the beginning of 2011 as soon as they took office. However, the new House likely would have dropped many of the concessions that President Obama pushed for, such as extending unemployment benefits and cutting payroll taxes.

Reversion to Pre-2001 Regime
If nothing was done to address the temporary estate tax repeal, then the nation would have automatically reverted to the pre-2001 estate tax regime. The estate tax exemption would have dropped to $1 million and the top tax rate would have increased to more than 55 percent in 2011 and later years.25 Many middle-class families would have been required to pay some estate tax because of the lower exemption threshold. It would have cost the government nothing, but would have broken many of President Obama's campaign promises. With passage of the "Big Deal," a permanent solution will still have to wait two more years. The same uncertainty faced at the end of 2010 will likely rear its ugly head again at the end of 2012. Since the "Big Deal" is only a temporary measure, if Congress does not pass permanent legislation, then taxpayers in 2013 will face reversion to the pre-2001 estate tax regime.

Conclusion
The political climate at the end of 2010 caused a great deal of doubt that there would be an easy compromise to resolve issues created by the temporary estate tax repeal. The campaign promises of newly-elected congressional leaders helped fuel the belief that an estate tax that both Congress and the President could live with (without backing out of their respective promises) was unlikely in the short term. Apparently, there was some incentive to finding "middle ground" to get a tax bill passed. Few wanted to see a tax increase at the start of 2011. Some newly-elected Senate and House members campaigned on the promise to extend all of the Bush tax cuts. While President Obama has vowed to raise taxes only on taxpayers who earn in excess of $250,000 annually (a small percentage of the total American population), a return to pre-2001 rates and exemptions certainly would have increased taxes for more than just those taxpayers.

One thing was certain at January 1, 2011: the estate tax would have reverted to its pre-2001 regime if Congress did not propose an acceptable measure before then. That would have been incredibly harsh on estates that would have otherwise been exempt from taxation under the old $3.5 million threshold. The lame duck session of Congress held no real promises of permanent resolution, and it was almost unrealistic to think that even a temporary compromise was a possibility. Few anticipated a deal of this magnitude being signed into law so quickly. The estate tax is back—the question now becomes what the estate tax will look like when consensus on a permanent measure is reached.

Mellany L. McDonald is a solo practitioner and owner of the Law Office of Mellany L. McDonald, PLLC. She practices in the areas of probate and estate planning.

Endnotes
1. Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, H.R. 4853, 111th Cong. (2010).
2. Urban Institute & Brookings Institution, Tax Policy Center 2010 Budget Tax Proposals: Make 2009 Estate Tax Permanent, Tax Topics (May 9, 2009), http://www.taxpolicycenter.org/taxtopics/2010_budget_estatetax.cfm.
3. See id.
4. See id.
5. The Trust Advisor Blog: U.S. Federal Estate Tax Repealed for 365 Days, http://thetrustadvisor.com/news/estatetaxrepealed/ (Jan. 1, 2010).
6. Glenn M. Karisch, Estate Tax Chaos Presents Problems, Opportunities (Jan. 1, 2010), http://www.texasprobate.com.
7. Future of the Federal Estate Tax, http://mhs.typepad.com/threepointfive-45/federal-estate-tax-bills-in-front-of-congress.html/ (Nov. 26, 2010).
8. Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Bill of 2009, H.R. 4154, 111th Cong. (2009).
9. See id.
10. The Responsible Estate Tax Act, S. 3533, 111th Cong. (2010).
11. Id.
12. Death Tax Repeal Act, H.R. 205, 111th Cong. (2009).
13. Fair and Simple Tax Act of 2009, H.R. 99, 111th Cong. (2009).
14. Joel Friedman and Andrew Lee, Permanent Repeal Of The Estate Tax Would Be Costly, Yet Would Benefit Only A Few, Very Large Estates (June 17, 2003), http://www.cbpp.org/cms/index.cfm?fa=view&id=1964.
15. Roberton Williams, Urban Institute & Brookings Institution, Wealth and Transfer Taxes: How could we reform the estate tax? (Nov. 29, 2007), http://www.taxpolicycenter.org/upload/Elements/II-9KEYELEMENTS_WealthTransferTaxes.final.pdf.
16. See id.
17. Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, H.R. 4853, 111th Cong. (2010).
18. See id.
19. Laura Saunders, The 'Death Tax' Is Reborn: The State of the Estate Tax, WAL. ST. J., Dec. 11, 2010, at B7.
20. Id.
21. Id.
22. Id.
23. Id.
24. Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010, H.R. 4853, 111th Cong. (2010).
25. Urban Institute & Brookings Institution, Supra note 2.