Estate Tax Legislation Now Coming to a Head in the House

When you hear the bushes shaking, you know something is about to jump out, but you still don’t know what kind of beast it will turn out to be.

Dear Readers Who Follow Washington Developments:

Capital Letter Number 19, dated October 26, 2009, speculated that the following week or two could be important for shaping 2009 estate tax legislation by the Democratic members of the House Ways and Means Committee.  Committee Chairman Charles Rangel (D-NY) seemed to have dropped a one-year extension of 2009 law from his vocabulary and was talking more in terms of making 2009 law permanent, as the Obama Administration’s budget proposals contemplated.  Among people who try to guess what Congress will do, making 2009 law permanent rather than extending it for just one year has probably been a minority view, but it has had some political appeal as well as offering the stability that most estate planners would welcome.

Ways and Means Democrats Consider an Extension of 2009 Estate Tax Law

Capital Letter Number 19 was optimistic in its estimate of timing.  While it is likely that Ways and Means Committee members talked about the estate tax during the lull before the November 7 floor vote on health care reform, a more definitive signal from Committee Democrats did not come until early on November 18, when they reportedly outvoted Chairman Rangel and agreed to go forward with only a one-year extension of the 2009 estate tax law after all.  But then they seemed to have second thoughts when Majority Leader Steny Hoyer (D-MD) asked them to reconvene that evening and urged them to embrace a permanent solution.

On the following day (November 19), Congressman Earl Pomeroy (D-ND), the Ways and Means Committee member whom Chairman Rangel had reportedly tapped to put the permanent statutory language together, introduced H.R. 4154, a very simple bill that would only freeze 2009 law, including the estate tax exemption of $3.5 million, the gift tax exemption of $1 million, the top rate of 45 percent, a stepped-up basis at death for appreciated assets, a deduction (and no credit) for state death taxes, and the special rules for conservation easements, section 6166, and allocation of GST exemption enacted in 2001.

Still Uncertain Prospects

Now, with the estate tax scheduled to be repealed in less than six weeks, we are witnesses to a dramatic standoff.  Lawmakers from the death tax repeal tradition who are still holding out for a lower rate and higher exemption – such as the bipartisan sponsors of the Berkley bill described in Capital Letter Number 19, the bipartisan supporters of the Lincoln amendment to the budget resolution described in Capital Letter Number 16, and Republican members of the Ways and Means Committee not formally involved in the process to date – see this as their last chance to use the leverage of the one-year repeal.  Others, who follow the drumbeat of “no tax cuts for the rich,” see a one-year extension of 2009 law as the best chance to regain the leverage, in this case the leverage of the 2011 return to the relatively low exemption and high rates of pre-2001 law.  In short, the House leadership’s preference for a permanent solution like H.R. 4154 is attracting barbs from both the right and the left.

It is easy to envision a three-way split.  No majority, no action, and in six weeks no estate tax.  Since it takes more effort to pass a bill than to not pass one, that outcome is possible.  But the view of Capital Letters will continue to be that the specter of repeal – ACTEC Washington Affairs Committee member and former Treasury attorney Beth Kaufman has called it a “train wreck”^[1] – is so unbearable that lawmakers will be forced to hold their noses and compromise to avoid it.  And in that scenario the compromise is most likely to be the middle H.R. 4154 position of making 2009 law permanent, especially since that is the position supported by the House leadership.

Meanwhile, on November 17, 2009, as if to emphasize the continued bipartisan interest in making 2009 law permanent, Senator Thomas Carper (D-DE), a member of the Finance Committee, and Senator George Voinovich (R-OH) introduced S. 2784, which would do just that – make 2009 law permanent.  In addition, under S. 2784, the $3.5 million applicable exclusion amount would be indexed for inflation, would be “portable” between spouses, and would be the same for both the gift tax and the estate tax.  S. 2784 is thus quite similar to Title III of the “Taxpayer Certainty and Relief Act of 2009” (S. 722), which Finance Committee Chairman Max Baucus (D-MT) introduced on March 26, 2009.  (See Capital Letter Number 15.)   But that still does not guarantee, in today’s political climate, how the Senate would receive any House-passed bill.

S. 2784 concludes by proposing that “[i]t is the sense of the Senate that any reduction in Federal revenues resulting from the provisions of, and amendments made by, this Act should be fully offset.”  But it is hard to tell how significant fiscal reminders like this are.  Ultimately, any estate tax legislation this year will be a political decision, made, appropriately, by politicians.

The Wild Card of Revenue Offsets

If the politicians do think they need to include revenue offsets in 2009 estate tax legislation, and (as appears likely) they will be finalizing the legislation in a hurry, then the central role Congressman Pomeroy has been given might tempt him to draw on his previous work in drafting H.R. 436 for an easily available template.  As described in Capital Letter Number 14, H.R. 436, which Congressman Pomeroy introduced on January 9, 2009, would have raised revenue by reinstating the 5 percent surtax as a “phaseout of graduated rates and unified credit” and by imposing special rules for entity-based valuation discounts.

Before 2002, the former 5 percent surtax created, in effect, a marginal rate of 60 percent for taxable estates between $10,000,000 and $17,184,000, but, in order to match today’s $3.5 million exemption, it would have to apply to taxable estates from $10 million all the way up to $41.5 million.  In states without a state estate tax, the marginal rate between $10 million and $41.5 million would be 50 percent (45 percent plus 5 percent), but in most states with their own estate tax the combined federal-state marginal rate would range from 56.9 to 58.0 percent.  It is not clear that lawmakers who remember a 55 percent rate have an appetite for marginal rates that much higher.

H.R. 436-style valuation rules would also be troublesome.  The core substantive provisions of H.R. 436 were as follows:

In the case of the transfer of any interest in an entity other than an interest which is actively traded…, the value of any nonbusiness assets held by the entity shall be determined as if the transferor had transferred such assets directly to the transferee (and no valuation discount shall be allowed with respect to such nonbusiness assets), and the nonbusiness assets shall not be taken into account in determining the value of the interest in the entity….

… [I]n the case of the transfer of any interest in an entity other than an interest which is actively traded…, no discount shall be allowed by reason of the fact that the transferee does not have control of such entity if the transferee and members of the family … of the transferee have control of such entity.

As critiqued in Capital Letter Number 14, this language basically codifies the concepts in the Clinton Administration’s budget proposals for fiscal 1999, 2000, and 2001, without addressing a number of technical concerns that ACTEC Fellows and others have identified over the years.  Many of those concerns, for example, appear to have been acknowledged in the proposals regarding valuation discounts in the Obama Administration’s budget proposals published on May 11.  (See Capital Letter Number 17.)  Dropping H.R. 436-style language into a 2009 bill at the last minute would interrupt the thoughtful study in Treasury and the Service that is reflected in the Administration proposals and subject a lot of entities and transactions to valuation rules that may be no more workable than the crazy quilt of current case law.

The omission of a 5 percent surtax or valuation rules from H.R. 4154 may be in part an acknowledgment of the unintended consequences such provisions would have and, in the case of the valuation discounts, an acknowledgment that the deliberative regulatory approach contemplated in the Administration proposals is likely to produce a more comprehensive, understandable, and workable set of rules.  Only time – now running out – will tell.

Ronald D. Aucutt

[1] Kaufman, “Estate Tax Legislation in 2009: Avoiding the Train Wreck,” 36 Estate Planning 37 (July 2009).