Death, Taxes, and the Candidates
[The candidates agree on certain aspects of the death tax, but they disagree sharply on the two major items: the exemption and the tax rate.]
online.wsj.com
›OCTOBER 15, 2008
By TOM HERMAN
Although taxes have become a major political battleground in the presidential campaign, Sens. Barack Obama and John McCain agree on a couple of estate-tax issues that could benefit many people and their heirs.
Both candidates agree on changing the law to make the federal estate-tax exemption "portable," senior advisers say. This issue is known as portability because the exemption per person -- $2 million this year and $3.5 million next year -- would become transferable from one spouse to the other, in effect doubling the surviving spouse's exemption. In essence, that means that spouses would be able to use each other's estate-tax exemption without first having to set up complex and costly trusts and take other steps that many people now feel obliged to do.
Advisers to the two candidates say such a change could greatly simplify estate planning and lead to fewer hassles for many married couples and their heirs. "Portability would be one of the most important changes in estate planning" in many years, says Carolyn R. Caufield, a partner at the law firm of Kelley Drye & Warren LLP in New York City.
The presidential candidates also agree on the idea of keeping today's system for valuing inherited property, including stocks and mutual-fund shares [the so-called step-up method for determining capital gains in which the cost basis is the value at the time of death rather than the original cost basis of the decedent]. But they disagree sharply on at least two major issues -- what the estate-tax exemption amount and top tax rate should be.
Because of tax-law changes in recent years, the federal estate tax now hits many fewer estates than it once did. The Internal Revenue Service received a total of only about 23,000 taxable estate-tax returns in 2006. That was down sharply from 52,000 returns in 2001. Most returns in both those years involved estates valued at $3.5 million or less. And only about 4,300 of the returns in 2006 were for gross estates of $5 million or more.
Even so, the estate tax, known derisively by critics as the "death tax," is still a hot political issue. Here is an update on the current law, where the candidates stand, and what their areas of agreement could mean for many families and their heirs:
Exemption and Rates. For 2008, the basic federal estate-tax exemption is $2 million per person, and the top estate-tax rate is 45%. Next year, the exemption is scheduled to jump to $3.5 million, the largest one-year increase in history. For heirs of wealthy individuals who die after Dec. 31, the tax savings could be enormous.
In 2010, the estate tax is supposed to disappear completely -- but most tax advisers think Congress won't allow that to happen. Starting in 2011, the tax is set to spring back to life with an exemption of only $1 million and a top tax rate on the largest estates of 55% [i.e. the schedule in effect before the Bush tax cuts].
Sen. McCain proposes raising the exemption "as soon as possible" to $5 million and cutting the top tax rate to only 15%, says Douglas Holtz-Eakin, senior policy adviser. Sen. Obama wants to keep the exemption at $3.5 million and the top rate at 45%.
Portability. Both candidates agree the exemption amount should be easily portable. "Families should not be required to undertake complex and unnecessary financial planning or be penalized for failing to take advantage of sophisticated financial strategies," says Jason Furman, economic policy director for the Obama campaign. The Democrats' nominee "believes we should eliminate the estate tax for 99.7% of families -- and this is part of his plan to accomplish that goal," says Mr. Furman.
Sen. McCain also favors portability. The Republican nominee "opposes situations where taxpayers may have unfavorable tax consequences" simply because they couldn't afford -- or didn't know -- "to seek sophisticated tax planning advice," says Mr. Holtz-Eakin. "All of the costs and effort involved in such planning would be unnecessary or greatly reduced if there was portability of the estate-tax exemption. Such a proposal also meets another of John McCain's goals of simplifying our complex tax code whenever we can."
Under current law this year, a married couple could leave a total of $4 million [i.e. twice the $2M exemption] to their children without federal estate tax "But because the exemptions aren't portable, quite a bit of planning is necessary to achieve this result," says John M. Olivieri, a tax partner at the law firm of White & Case LLP in New York City.
Suppose a husband and wife each has $2 million. The husband dies and leaves everything to his wife. Although there's no federal estate tax because of the marital exemption, the wife now has a $4 million estate but only a $2 million exemption, Mr. Olivieri says. Consequently, if she dies this year and leaves her $4 million to her children, "her estate will be hit with a federal estate tax of about $900,000," based on this year's rate structure, Mr. Olivieri says. "A similar problem arises if the entire $4 million is owned by the husband and the wife dies first."
To avoid the problem, "many married couples expend considerable time, effort, and money to avoid wasting their combined federal exemptions," says Mr. Olivieri. "But if the exemptions were portable, none of this would be necessary." However, even if the exemption does become portable for federal estate-tax purposes, Mr. Olivieri points out that many people may need to take special estate-planning steps anyway because of state-tax issues.
Although many tax advisers do expect major estate-tax changes next year, no matter who wins the presidency, don't count on them just yet. Even though the two candidates agree on portability, nobody knows how quickly such a change might happen, what the effective date might be and how the fine print of legislative language would read.
But "my sense is that portability would have bipartisan congressional support," says Blanche Lark Christerson, managing director at Deutsche Bank Private Wealth Management in New York. "It also could simplify people's planning and be a good thing."
However, many people still might benefit from setting up trusts and taking other steps anyway, Ms. Christerson says. That includes many people who live in states that have "decoupled," or separated, from the federal estate-tax system. "Also, bear in mind that even if there were no potential tax consequences and apparent need for a trust, you still might want one" for other reasons, such as protecting assets from creditors or other factors.
Valuations. This is a key issue when calculating capital-gains taxes on the sale of inherited assets. Here's an example: Suppose your cousin dies and leaves you stock he originally purchased decades ago for $100,000 and the value of that stock has grown to $500,000 as of the date of his death. Your tax basis typically would be $500,000 -- or, under certain circumstances, the value six months after the date of death. That means you don't have to figure out what your cousin originally paid for that stock. This system is scheduled to continue through next year and undergo major changes in 2010. Critics say those changes would create additional complexity and impose unfair recordkeeping burdens on taxpayers. Advisers to both candidates have said the candidates want to retain the current system.‹ |
