Estate tax gap could result in lawsuits

Congress’s failure to fill a one-year gap in the estate tax could result in serious litigation over inheritances, according to tax experts.

The estate tax is set to disappear on Jan. 1 for one year before being reinstated in 2011 at a higher maximum rate of 55 percent.

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The House has approved legislation to extend the estate tax at a maximum rate of 45 percent through 2010, but the Senate is not expected to act because of GOP objections. Most Republicans want to eliminate the estate tax, a longtime goal of the conservative movement.

Senate Finance Committee Chairman Max Baucus (D-Mont.) this week said Democrats will seek to retroactively extend the tax upon the Senate’s return to Washington next year.

But in the meantime, deaths, trust terminations or trust distributions involving substantial amounts of money inevitably will occur, according to a research note by Deloitte Tax.

And that’s likely to lead to extensive litigation if and when Congress re-imposes the tax on grounds that the Constitution forbids Congress from retroactively collecting the tax.

Given the amounts of money, “it’s almost certain that people will litigate,” said Clint Stretch, a tax expert at Deloitte.

The Senate’s inability to consider the matter surprised people on both sides of the issue, and groups that favor the estate tax are urging the Senate to act quickly.

In a Dec. 17 letter to senators, Americans for a Fair Estate Tax said the decision to let the tax expire was “incomprehensible.” It said the tax’s elimination would be a boost to the wealthy that would negatively affect charitable giving and hurt government coffers.

“Repeal of any weakening of the tax would result in significant loss of revenue for vital public programs and infrastructure, and would benefit only the largest one in 500 estates that are subject to the tax at its current level,” said the group, which includes a number of labor organizations and left-leaning groups.

Only estates larger than $7 million per couple or $3.5 million for individuals are subject to the estate tax.

Democrats warn those under that threshold will be hit by a higher capital gains tax because of Congress’s inaction.

Under the rules set to go into place on Jan. 1, a capital gains tax of 15 percent would apply to estates above $1.3 million. The tax would be calculated based on gains accrued since the estate was purchased.

“The people that are most likely to be hurt by this are the people who have an estate between $1.3 million and $7 million,” said Lee Faris, of United for a Fair Economy, which wants to extend the estate tax.

Stretch, however, said those taxes would not be due until 2011, giving Congress time to address the problem.

The expiration of the estate tax also eliminates the generation-skipping transfer (GST) tax for a year, which could have a huge impact on the transfer of wealth.

Under the 2009 tax code, a grandparent giving $10 million to a grandchild would have to pay the GST and a gift tax. Someone at the highest marginal estate tax rate who had already filled his or her $3.5 million GST tax exemption would owe more than $11 million in combined gift and GST taxes on the $10 million gift, according to an estimate by Craig Janes at Deloitte Tax.

In 2010, that donor would only pay the gift tax, set to be 35 percent next year, or $3.5 million on the $10 million gift.

The Congressional Budget Office expects receipts from estate taxes to virtually disappear in 2011 before rising to about $32 billion in 2012, when the higher estate tax is set to kick in, according to a post Friday on the CBO director’s blog.

Gift tax receipts, in contrast, are expected to surge to a high level in 2011 because of the decline in the top rate of the gift tax from 45 percent to 35.

Given the partisanship on display in the Senate, observers are not confident the Senate will act quickly to re-impose the tax next year.

“I’m not at all confident they’ll do it anytime soon,” said Stretch, who noted the Senate was also unable to agree to extend several uncontroversial tax extensions at the end of the year.