Few people on Capitol Hill or in financial-planning offices expect the new law to survive the decade intact -- maybe not even the next Congress. Small-business owners, who have lobbied hard for repeal of the estate tax, will now be modifying their estate planning, all the while pondering the future's many political uncertainties.
"It's beyond confusing. It's absolutely ludicrous," says Stuart Sorkin, an attorney at tax specialists Frank and Associates in Bethesda, Md. He's telling his clients -- just as Senate Majority Leader Tom Daschle has warned the public -- to assume the law will be changed again. In the meantime, financial planners and owners of estates worth more than $1 million are left to parse the good, the bad, and the nonsensical in the new law. The highlights:
Inherit More, Owe Less. Starting next year, the size of estate that can be inherited tax-free is $1 million, up from $675,000 this year. Also next year, the top tax rate (paid on inherited value over $3 million) falls to 50%, compared to 55% this year. The amount that can be inherited tax-free rises incrementally until it reaches $3.5 million in 2009, and the top tax rate falls until it hits 45% in 2007. The estate tax disappears altogether in 2010, but only for that year.
Even though the law calls for pre-Bush rates and rules to apply for 2001, few people expect Congress will ever let the estate-tax exemption fall below $1 million again, no matter what else changes. "The vast majority of the public aren't supporting the death tax," says Dan Blankenburg, vice-president for the National Federation of Independent Business.
Hello, Capital Gains. Under the old tax law -- and under the new one through 2009 -- the value of inherited property is assumed to be its value at the owner's death, which means heirs pay no capital-gains tax. But in 2010, and for that year only, heirs will have to pay capital-gains tax on the amount the inherited property has appreciated since its former owner acquired it. This applies to any inheritance over $1.3 million, or an estate over $3 million inherited by a surviving spouse.
That provision is "a nightmare," says Harvey Berger, tax partner with Grant Thornton accountants. "Let's say you inherit an antique coin collection. How in the world can you ever figure out what the original owner paid when he bought each coin?" Even more pedestrian investments such as stocks and bonds could be difficult to valuate. If Uncle George kept everything with a stockbroker or handful of stockbrokers and kept careful records, you may be able to know what he paid for each investment. Similar legislation on capital gains for inheritances was passed during the Carter Administration but was repealed a year later, Berger points out.
States Affected. In 2005, the estate-tax law will no longer earmark up to 16% for state-government coffers. It's expected that states will impose their own taxes on estates rather than suffer the loss in revenue. "Congress reached their hand directly into the pockets of the states with that one," Berger says.
Charities Losing Out. Cutting estate taxes is expected to cause a drop in the amount given to charities, since fewer people will be looking for the estate-reduction and tax-deduction benefits of such gifts.
Biggest Estates. The current 5% surtax on estates worth more than $10 million is repealed, beginning next year.
The Cost of Giving. Taxes on gifts of more than $10,000 per person per year will gradually be lowered. Also falling gradually are taxes on the so-called "generation-skipping gifts" to grandchildren.
Not Simple. One of the biggest complaints about the pre-Bush estate tax was the costly, complicated tax planning required to avoid paying it, such as setting up trusts, gifting the estate gradually over a period of years, and buying life-insurance policies to cover the taxes due at the time of death. The changes to the estate tax under the new law don't simplify such planning for many small-business owners, say the pros.
"Anyone with an estate over $1 million needs to rethink what they've done," says Berger, including redoing their wills to conform to some of the changes. That's why, even though more small-business owners won't owe estate tax under the current law, Sorkin still sees it as "the full-employment act for lawyers and accountants -- it doesn't give anybody a break from intricate planning."
Blankenburg of the NFIB, however, sees the new estate-tax law as a victory. If it remains as is through 2009, he estimates some 45,000 more small-business owners would be exempt from paying the tax. He acknowledges what happens after that is anyone's guess. "Would we have liked to see the whole thing repealed? Sure. But this is Washington."
For now, as the Economic Growth and Tax Relief Reconciliation Act stands, the challenge for many small-business owners and their financial advisers is to find the relief. By Theresa Forsman in New York