Next year had been shaping up as a great year to get a big inheritance — no federal taxes on it. Congress, however, has other plans for the few wealthy heirs expecting a big boon. Uncle Sam may take a 45 percent cut after all.
Under current law, the federal estate tax is scheduled to temporarily disappear next year before returning in 2011 at an even higher rate. But the House is expected to vote as early as Thursday on a bill that would permanently extend the current top rate of 45 percent on estates larger than $3.5 million.`
Married couples, with a little estate planning, can exempt a total of $7 million from the federal estate tax, leaving less than 1 percent of all estates subject to the tax this year.
The Senate is considering similar legislation, though senators are busy trying to overhaul health care, meaning they will probably have to scramble to address the estate tax by the end of the year.
House Majority Leader Steny Hoyer, D-Md., said it is important to set a permanent estate tax so rich families and small business owners can plan accordingly. He said exempting estates as large as $3.5 million from the tax will protect all but the wealthiest Americans.
The quirk in the law, in which the estate tax would disappear for only a year, came out of a series of tax cuts enacted in 2001. Many Republicans, who controlled Congress at the time, wanted to permanently repeal the estate tax, but they settled on a gradual reduction, with a one-year repeal, to reduce the impact on the federal budget deficit.
In 2011, the estate tax is scheduled to return, with a $1 million exemption and top rate of 55 percent, unless Congress acts.
Permanently extending the tax with a top rate of 45 percent on estates larger than $3.5 million would cost an estimated $234 billion in lost revenue over the next 10 years. It would be paid for with increased borrowing.
A 'death tax?'
Some Republicans and small business groups want to permanently repeal the estate tax, which they have labeled a "death tax."
"I don't think death in and of itself should be a taxable event," said Rep. Dave Camp of Michigan, the top Republican on the tax-writing House Ways and Means Committee. Camp said he is concerned that the $3.5 million exemption would not be indexed for inflation, meaning more and more estates would be subject to the tax in the future.
Currently, the tax affects few estates. In 2009, about 5,500 estates will be subject to the tax, according to projections from the Tax Policy Center, a Washington think tank. That's 0.23 percent of all estates.
Nevertheless, the issue has gained political traction.
Some opponents simply don't know how few people get hit by the tax, said Roberton Williams, a senior fellow at the Tax Policy Center. "The only thing I can figure is, they think they're going to hit the lottery, and they don't want to be hit" by the tax.
Dick Patten, president of the American Family Business Institute, an organization formed to fight the estate tax, said the tax hits small businesses with a lot of expensive equipment.
"If you've got a smaller business that's much more service oriented, $3.5 million probably allows you to escape under the line," Patten said. "But if you have any kind of business that requires capital, then this puts your business at risk."