Estate Tax News: Proposed Exemption Fixed at $3.5 Million

On 3/26, Senate Finance Committee Chairman Max Baucus (D-Mont.):

announced legislation that would make existing tax breaks permanent for working families and individuals including the child tax credit, marriage penalty relief, and lower middle-income tax rates among other provisions. The measures were originally passed as part of tax legislation in 2001 and 2003, but are set to expire in 2010. Baucus unveiled his proposal after a Finance Committee hearing today that examined the affect of the current economy and the U.S. tax code on America’s middle class.

“Today we’re offering a piece of certainty during an uncertain time for millions of hardworking, honest Americans. These measures are not excessive or outrageous, but timely and targeted, and will build on earlier efforts to stabilize the economy,” said Baucus. “By guaranteeing a little extra cash in the pocket of working moms and dads, and by making sure that the AMT and the estate tax can move with the economy, we avoid sweeping tax increases for millions of American families. By promising spouses tax fairness in marriage, giving help to those helping others through adoption, and by giving lower-wage workers confidence at a critical time, we can restore our footing, and begin to climb back to a position of national strength and economic security.” 

The estate tax is the biggest piece of this particular legislation, in my opinion anyways:  Rather than being repealed in 2010 (as its set to do under current law), the estate tax exemption would sit at $3.5 million and be indexed for inflation in $10,000/year increments starting in 2011.  The tax rate would be fixed at 45% – the same as it is now.  The biggest news though is the “marital deduction portability.”  Under the proposed law, when one spouse passes away, their estate can pass to the surviving spouse without the need for a credit shelter trust.  If the surviving spouse passes away with an estate larger than the then applicable individual exemption amount, they can elect to use the “aggregate deceased spousal unused exclusion amount.”  The use of the first deceased spouse’s deduction requires an election on the tax return of the second to die and can be up to the full amount of the unused exemption.  Thus, $7 million can pass free of estate tax on the death of the second spouse.

Greg Herman-Giddens of the North Carolina Estate Planning Blog, wisely writes:

If this bill becomes law, the first tendency of many couples with [federally] taxable estates will be to revise their wills or trusts to do away with the credit-shelter (bypass) trusts.  However, there will still be compelling reasons to have such trusts.  With a credit-shelter trust, growth in the value of the assets is also protected from estate taxes, while that is not necessarily true if a couple relies on exemption portability.  In addition, the credit shelter (or marital) trust provides valuable protection from mismanagement, creditors, and future spouses.

Awesome Greg.  I couldn’t have said it better myself.

A full summary of the bill is below:

The Taxpayer Certainty and Relief Act of 2009

I. Permanent Middle Class Tax Relief

Individual Tax Rates. Current ordinary income tax rates are imposed at 10, 15, 25, 28, 33, and 35%. These tax rates expire at the end of 2010. The proposal would make permanent the 10, 25, and 28% tax rates. (The 15% tax rate is already permanent law.)

Capital Gains and Dividends. The proposal would make permanent the reduced tax rate on capital gains and dividends for taxpayers in the 10, 15, 25, and 28 percent brackets. The 2003 tax bill created a new tax rate of 15 percent (5 percent for low-and middle-income taxpayers, going to zero percent in 2008) for dividends. Prior to passage of this bill, dividends were taxed at ordinary income rates. The 2003 bill also reduced the capital gains tax rate from 20 percent (10 percent for low- and middle-income taxpayers) to 15 percent (5 percent for low- and middle-income taxpayers, going to zero percent in 2008). These reduced tax rates were originally set to expire at the end of 2008, but were extended until the end of 2010 in the “Tax Increase Prevention and Reconciliation Act of 2005” (TIPRA).

Child Tax Credit.Generally, a taxpayer may claim the child tax credit to reduce income tax liability by up to $1,000 for each qualifying child under the age of 17. If the amount of a taxpayer’s child tax credit is greater than the amount of the taxpayer’s income tax liability, the taxpayer may receive a refund if the income threshold is met. The Economic Growth and Tax Relief Reconciliation Act of 2001 set the income threshold for child tax credit refundabilityat $10,000 (indexed). The American Recovery and Reinvestment Act decreased the threshold for the 2009 and 2010 tax years to $3,000. The proposal would make these changes to the child tax credit permanent.

Marriage Penalty. A “marriage penalty” exists when the combined tax liability of a married couple filing a joint return is greater than the sum of the tax liabilities of each individual computed as if they were not married. A “marriage bonus” exists when the exemption amounts and rate brackets are larger for the joint returns filed by married couples than for singles’ returns. As part of the 2001 tax cuts, the standard deduction for married filers was scheduled to increase annually until 2009. In addition, the bill eliminated the marriage penalty in the 15% tax bracket and for the earned income tax credit. The marriage penalty relief expires on December 31, 2010. The proposal would make the marriage penalty relief permanent.

Dependent and Child Care Credit.The dependent care credit allows a taxpayer a credit for paid child care expenses for qualifying children under the age of 13 and disabled dependents. The credit is 35% of eligible expenses. This rate decreases by 1% for each $2,000 of income above $15,000, but the rate never falls below 20%. Eligible expenses are limited to $3,000 for one child, and $6,000 for two or more children. (After 2010, the amount of eligible expenses returns to the pre-2001 amounts of $2,400 for one child and $4,800 for two or more. In addition, the 35% credit rate decreases to 30% and the income threshold decreases to $10,000.) The proposal would make 2009 law permanent.

Earned Income Tax Credit. The EITC is a refundable tax credit available to low wage workers. Because the credit is refundable, a taxpayer will receive a refund if the amount of the EITC is greater than the amount of the income tax liability or if no income tax liability exists. The American Recovery and Reinvestment Act increased the credit rate for taxpayers with three or more children from 40% to 45% and increased the phase out range for all married couples filing a joint return (regardless of the number of children) by $1,880. The proposal would make these changes permanent.

Adoption Credit and Adoption Assistance Programs. Current law allows a maximum adoption credit of $10,000 per eligible child and a maximum exclusion of $10,000 per eligible child. These benefits are phased-out for taxpayers with modified adjusted gross income in excess of certain dollar levels. These tax incentives go back to $5,000 per child ($6,000 for child with special needs) after 2010. The proposal would make 2009 law permanent.

II. Permanent Alternative Minimum Tax Fix

For the 2009 tax year, the American Recovery and Reinvestment Act provided a patch for the AMT, setting the exemption amount at $46,700 (individuals) and $70,950 (married filing jointly), and allowed the personal credits against the AMT. When this patch expires, the exemption amounts will return to $33,750 (individuals) and $45,000 (married filing jointly) and the personal credits will not be allowed against the AMT. The proposal would make the 2009 exemption levels permanent and index them for inflation. In addition, the proposal will permanently allow the personal credits against the AMT.

III. Permanent Estate Tax Relief

Under current law, U.S. citizens and residents must pay taxes on transfers of property both during life and at death. These taxes are due under three separate tax systems: the estate tax, the generation-transfer skipping tax, and the gift tax. Currently, the top tax rate for all three taxes is 45%. Both the estate and generation-skipping transfer taxes currently have a $3.5 million exemption for individuals ($7 million for couples). The gift tax has an exemption of $1 million ($2 million for couples). For the 2010 tax year, the estate and generation skipping transfer taxes are repealed. In the same year, the gift tax rate will fall to 35%. In 2011, the estate, generation skipping transfer, and gift taxes are scheduled to revert back to pre-2001 levels, with an exemption of $1 million, a 55% rate, and a 5% surtax on large estates.

Thanks to this story at Scottrade for the great detail.

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