As estate planning attorneys, we like certainty. We craft language to avoid ambiguity and plan with clients to identify and eliminate unnecessary risk. The estate tax system, however, is in a state of flux. Unless Congress intervenes (as we expect they will), the federal estate tax is scheduled to disappear in 2010, only to return in 2011 with higher tax rates and lower exemptions than we currently enjoy. This uncertainty presents a challenge, but does not preclude effective tax planning.
Nothing. Well, almost nothing. If you die in 2008, the effective federal estate tax exemption available to your estate is $2 million. If your estate (including certain large gifts made during life) is below this amount, no federal estate tax will be due.
The $2 million exemption is potentially available to each spouse of a married couple, allowing them to collectively pass $4 million free from federal estate tax, but proper planning is required to preserve this potential. Under current estate tax laws, the individual exemption is scheduled to increase to $3.5 million in 2009. Beyond 2009, the situation is less clear.
What's Almost Certain
It is almost certain that the federal estate tax isn't going to be permanently repealed anytime soon. Several years ago, repeal appeared to be a realistic possibility. A change in control of Congress, hurricane Katrina, extended and expensive military campaigns in the Middle East and the general economic downturn have stalled any momentum toward repeal.
If your estate is large enough that estate taxes are an issue and your strategy has been to wait for repeal, it's time to start formulating a new plan of attack. Opportunities are available to reduce or eliminate the estate tax burden. Give us a call and we would be happy to discuss them with you.
Although current law provides for the elimination of federal estate tax for one year only in 2010, that magical estate-tax-free year is unlikely to materialize. It is widely expected that Congress will implement some permanent federal estate tax exemption before 2010.
Because 2008 is an election year, that legislation is more likely to come in 2009, but several proposals have already been suggested. Most prognosticators predict a permanent exemption somewhere between $3.5 million (the amount already scheduled for 2009) and $5 million per person. Congress will also need to determine the rate(s) at which amounts over the exemption will be taxed — currently a flat 45 percent, but the highest marginal rate was 55 percent or higher as recently as 2001. For very large estates, the rate of taxation is even more important than the exemption amount.
Given that the anticipated changes in the federal estate tax system are likely to come during the next president's administration, it is worth noting the candidates' stated positions. Senator McCain has publicly supported a $5 million per person exemption (indexed for inflation) with a 15 percent tax rate on assets above the exemption. Senators Obama and Clinton have each publicly supported a $3.5 million per person exemption with a 45 percent tax rate on assets above the exemption — essentially making the current 2009 rules permanent.
The possibilities are limited only by Congress's imagination and ability to agree upon a solution. Fundamental changes are unlikely, but two specific issues are worth noting.
First, Congress appears to be seriously considering making the federal estate tax exemption “portable” between spouses. That is, if the first spouse dies, but fails to make full use of his or her federal estate tax exemption, the unused exemption could later be used by the surviving spouse. This would be particularly beneficial in instances where the spouse who dies first has relatively few assets or has not adequately planned to preserve his or her exemption (for example, if most assets were held jointly between the spouses — generally a bad idea for estate tax planning). The “portability” of the federal estate tax exemption is not a complete substitute for proper planning and asset allocation between spouses, but would relieve some of the tax burden when this has not been (or cannot be) accomplished.
A second, and less welcome, possibility is the reemergence of a state estate or inheritance tax system. The discussion above relates only to the federal estate tax, because Michigan has had no estate or inheritance tax since 2004. Michigan's estate tax laws are still on the books, but the tax is defined in terms of a federal estate tax credit that was phased out between 2001 and 2004. We expect Congress to address federal estate taxes before 2010, but if it doesn't act, this federal credit will reappear in 2011 — and with it will come the return of the Michigan estate tax.
If Congress does act, that doesn't foreclose the possibility of a Michigan estate or inheritance tax. A number of states that, like Michigan, had previously defined their state estate tax in terms of this federal credit have enacted legislation since 2004 to create a state inheritance tax or estate tax regime that is independent of the federal credit. Given the state's financial condition, it is certainly possible that Michigan may follow the lead of those other states to capture some of this lost revenue.
What's Next for You
Estate taxes are complicated and planning is easy to delay or ignore. The tax dollars potentially at stake, however, suggest that those desiring to pass wealth to their family rather than to their government must plan wisely. We would welcome the opportunity to discuss your circumstances and ways in which to minimize your estate tax liability. Please give us a call if we can be of assistance.