Fiscal Cliff Deal Impact On Estate TaxesJanuary 2, 2013

Fiscal Cliff Deal

Early this morning, the U.S. Senate, by a vote of 89 to 9, passed a bill designed to back the nation away from the fiscal cliff—potentially averting a critical challenge to the nation’s economic recovery and forestalling a feared negative reaction from the stock markets upon opening Wednesday morning. The agreement means an increased tax bill for those earning more than $400,000—as the current top rate of 35 percent rises to 39.6 percent. 

Wealthy Americans (often called the 1 Percent) who make their money from investments, rather than paychecks, were losers in the fiscal-cliff deal. In addition to higher income taxes, those who make above $400,000 will now be subject to a 20 percent tax rate on their capital gains and dividends. This increase to 20 percent was far less than the 40 percent sought by the Obama Administration. The fiscal cliff wasn’t all bad news for the wealthy, however: They can still bequeath up to $5 million tax-free, with any additional money taxed at 40 percent. That’s greater than the current 35 percent estate tax rate, but less than the 55 percent rate on assets over $1 million that would have gone into effect without a deal.

So what does the fiscal deal mean for what has been referred to as the “death tax ” and inheritance tax?

Wealth Transfer Taxation

Includible in a decedent’s gross estate for estate tax purposes is “all property to the extent of the decedent’s interest at death.” This means that a decedent’s “walk around” wealth is subject to tax at death. Therefore, what you own and pass under your will or intestacy is subject to estate taxes. To be a taxable estate requires the total tax base exceed the applicable exclusion amount which before the fiscal deal was $5 million. Under the fiscal cliff deal, the $5 million exemption remains, the estate tax increases to 40 percent (up from 35%), and is indexed to inflation. In other words, the first $5 million of any estate would not be taxed, but the rest would be at a 40 percent rate, with that $5 million exemption growing each year with inflation.

Scenarios For Estate Taxes

Although the estate tax does not affect many households (roughly 3,730 households will pay the estate tax in 2013 at its $5 million/40% rate), it does have a significant impact on the federal budget.  Estate taxes at the current $5 million/35% rate were projected to bring in nearly $182 billion in revenue for the federal budget from 2013-2022. The fiscal cliff deal adjustment from 35% to 40% will add a projected $25 billion in additional federal revenue in the same time period.

In order to adjust the estate tax rate, the nonpartisan Tax Policy Center looked at four scenarios. Below are the four scenarios they considered and what they mean for rates and revenues:

• $5 million exemption, indexed to inflation, with 35 percent tax rate, $182 billion in federal revenue (2013-2022). This was the estate tax policy until the fiscal deal was reached.
• $3.5 million exemption, indexed to inflation, with 45 percent tax rate, $284 billion in federal revenue (2013-2022). This was the Democrats’ preferred position during negotiations.
• $3.5 million exemption, not indexed to inflation, with 45 percent tax rate, $310 billion in federal revenue (2013-2022). This was the policy in 2009, before the estate tax was phased out entirely in 2010.
• $1 million exemption, not indexed to inflation, with 55 percent tax rate, $574 billion in federal revenue (2013-2022). This was the policy under Bill Clinton, which was set to come back in 2013 in the absence of a deal.

The resulting deal of $5 million/40% indexed to inflation was the result of concessions made during negotiations.

Stepping Away From The Cliff

It is often said that the two certainties in life are death and taxes. For the moment at least, at death, the latter of the two is only a certainty if your estate exceeds the $5 million exemption amount. As Congress and the Administration grapple with the budget and fiscal issues, tax exemptions such as the estate tax will continue to be a key element in determining the nation’s financial future.

Ryan A. Hintzen

Attorney

The Hintzen Law Firm, PLLC