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Restore the Estate, Gift, and Generation-Skipping Transfer Tax Parameters to 2009 Levels

In 2001, Congress voted to phase out the estate tax gradually and repeal it entirely in 2010. The 2010 tax act reinstated the tax with an effective $5 million exemption and a 35 percent tax rate. The act also for the first time allowed portability of the exemption between spouses: any of the $5 million exemption not used when one spouse dies may be added to the exemption available for the second spouse (if he or she has not remarried). However, unless Congress acts, the estate provisions in effect prior to 2001 would be reinstated starting in 2013, Under these provisions, estates valued at $1 million or more would again be subject to tax at progressive rates as high as 60 percent, and portability would disappear.*

The Obama budget proposes permanently setting the estate tax at its 2009 level beginning in 2013: estates worth more than $3.5 million would pay 45 percent of taxable value over that threshold.** It would also make portability permanent, allowing couples to share a combined exemption of $7 million. Relative to current law, the proposal would cost $312 billion in forgone revenues through 2021.

The Tax Policy Center estimates that about 3,600 estates will owe estate tax in 2012, representing less than 0.2 percent of deaths in that year. If the tax reverts to its pre-2001 level in 2013 as scheduled, nearly 53,000 estates—about 2 percent of decedents—will owe a total of more than $40 billion in tax. Making the 2009 estate tax permanent would reduce the number of estates owing tax to about 7,500 and the total tax to roughly $22 billion. All three of those versions of the tax would affect only the estates of very wealthy people.

The exemption and the tax rate have different effects on larger and smaller estates. A larger exemption prevents more estates from paying any tax but has relatively little effect on the amount of tax paid by the largest estates. In contrast, a lower tax rate reduces the tax owed for all taxable estates but saves the most money for the largest estates. Compare, for example, raising the exemption from $1 million to $3.5 million with cutting the tax rate from 55 percent to 45 percent. The exemption increase would reduce the number of taxable estates by more than 80 percent from about 53,000 to roughly 7,500 in 2013 and would save larger estates $1.38 million in tax (at a 55 percent rate). The rate cut would have a much larger effect for large estates: an estate with a taxable value of $5 million (after the exemption and any deductions) would save $500,000 while an estate worth $500 million would save $50 million in tax.

Additional Resources

Tax Topics: Estate and Gift Taxes.
Tax Policy Briefing Book: Key Elements of the U.S. Tax System: Wealth Transfer Taxes.

Modify Estate and Gift Tax Valuation Discounts and Make Other Reforms

In addition to making them permanent at their 2009 levels, the president proposes a number of changes to estate, gift, and generation-skipping transfer taxes, in part to simplify the tax and in part to reduce opportunities to avoid or minimize tax liability. In combination, the various proposals would increase revenues by $24.5 billion over ten years.

  • Require consistency in value for transfer and income tax purposes

Assets transferred by gift or bequest must be valued in specified ways in determining estate and gift taxes. The resulting value generally becomes the recipient’s basis for the asset. The administration proposal would require recipients to use as their basis no higher value than that used by the donor and require that either the donor or the estate executor provide recipients with appropriate values. As a result, recipients of gifts or bequests could not reduce taxes they would subsequently owe on asset sales by claiming a higher basis and hence a lower capital gain. The administration estimates that the provision would raise about $2 billion over 10 years.

  • Modify rules on valuation discounts

Transfers of property by gift or bequest are generally subject to gift or estate tax. Provisions in the Internal Revenue Code attempt to prevent various methods of reducing the value of such transfers—and hence the applicable tax—but some restrictions have become less effective. The president proposes to limit valuation discounts on family-controlled entities. The provision would increase revenues by about $18 billion over 10 years.

  • Require a minimum term for grantor-retained annuity trusts

If an interest in a trust is transferred to a family member, tax law requires that any interest retained by the grantor have zero value in determining any transfer tax except if the retained interest is “qualified.” One case of qualified interest is a grantor-retained annuity trust (GRAT) in which the grantor receives the annuity for a specified period (based on how long the grantor expects to live) and the residual trust passes to beneficiaries. In such a case, the present value of the annuity is subtracted from the value of the trust in determining transfer taxes. (If the grantor dies during the term of the annuity, some portion of the trust’s assets is included in the decedent’s estate.) GRATs can minimize transfer taxes, particularly if the trust’s assets appreciate in value. Minimizing the term of the GRAT reduces the likelihood that the grantor will die during its term.

The president proposes to require that GRATs have a minimum term of 10 years, that any remainder interest have a value greater than zero, and that the annuity cannot be reduced during the GRAT’s term. Those restrictions would minimize the value of the GRAT by increasing the risk that the grantor dies during its term and thus loses potential tax savings. The provision would raise revenues by about $3 billion over 10 years.

  • Limit duration of generation-skipping transfer tax exemption

The president proposes to limit the tax exemption for generation-skipping transfers (GSTs) by limiting the term over which such exemption applies. The provision aims to prevent perpetual trusts through which assets can pass tax-free through multiple generations. The provision would have a negligible effect on revenues.

  • Coordinate Certain Income and Transfer Tax Rules Applicable to Grantor Trusts

Grantor trusts may face different ownership rules with regard to income tax and transfer taxes, which may create opportunities to design transactions between the trust and its owner that transfer wealth without transfer tax liability. The president proposes to align ownership rules for transfer taxes with those for the income tax to remove such opportunities. The change would affect only new grantor trusts established after enactment of this provision and transactions involving existing trusts that occur after that date. The provision would increase revenues by about $900 million over 10 years.

  • Extend the Lien on Estate-Tax Deferrals Provided under Section 6166 of the Internal Revenue Code

Estates that contain certain closely held business interests may defer payment of estate tax for up to 14 years to avoid immediate imposition of the tax harming the business. Businesses nonetheless sometimes fail during the payment period, potentially costing the government lost revenue. To avoid such loss, current rules impose a lien on the entire estate to cover the deferred tax liability but such liens expire bout five years before the deferred tax is fully due. The president would extend the period covered by the lien to match the duration of the deferral. The provision would increase revenues by about $160 million over ten years.

Additional Resources

Tax Topics: Estate and Gift Taxes.
Tax Policy Briefing Book: Key Elements of the U.S. Tax System: Wealth Transfer Taxes.

* The gift and generation-skipping transfer (GST) taxes followed similar paths—$5 million lifetime exemptions and 35 percent tax rate through 2012, reverting to a $1 million exemption and 60 percent top tax rate in 2013.
** The GST would have the same $3.5 million exemption as the estate tax; the lifetime gift tax exemption would be $1 million. Both taxes would match the estate tax’s 35 percent tax rate.