Prepare for the Return of the Estate Tax

It’s Coming Back! The Estate Tax is coming back. That is the growing consensus of observers of what is happening on Capital Hill.

$3,500,000 exemption for 2009. This year, 2009, each person has an exemption from federal estate taxes of $3,500,000. This means that unless you have life insurance, real estate, savings and retirements funds in excess of $3,500,000, you do not pay any federal estate tax. If you live in Virginia, you don’t have any Virginia estate tax. But, if you live in DC or Maryland, you have estate taxes if you have more than $1,000,000.

Easy to be a millionaire. For many people, it is surprisingly easy to have an estate over $1,000,000, but difficult to exceed $3,500,000. Let us say you bought a house for $50,000 and it is now worth $500,000. You have a retirement fund of $150,000 and other savings of $75,000. We are talking about someone who considers themselves as middle class and not rich. They also have a small term life insurance policy with a death benefit of $250,000 and another $150,000 life insurance from their work. The death benefit of the life insurance is part of their taxable estate if they die while the insurance is in effect. Under the estate tax calculations with a $1,000,000 exemption, you have a taxable estate of $1,150,000.

Wealthy Escape at $3.5 million. Compare this to Mr. And Mrs. Wealthy. They have $1,000,000 in real estate, $1,000,000 in investments, another $2,000,000 in a family owned business, and insurance of $2,000,000. Their total taxable estate is $6,000,000, but they pay no estate tax when the estate tax exemption is $3,500,000 per person and their living trusts both use their $3,500,000 exemption (Two times $3,500,000=$7,000,000 which is greater than $6,000,000).

Bush Taxes Cuts Expire. The $3,500,000 exemption is part of the phase out of the estate tax under the Bush tax cuts. Next year, there is a complete elimination of federal estate taxes. But at the end of 2010, the Bush tax cuts expire. Rumors are that at the end of 2009, Congress will extend the $3.5 million exemption for only one year, through 2010. Without further legislation, the exemption automatically goes back to the $1,000,000 exemption in 2011 with rates as high as 55%.

$3,500,000 Was Here to Stay. President Obama’s election platform included a promise to keep the exemption at $3,500,000 and he implements his promise in his budget assumptions for future years by use of a $3,500,000 exemption. Earlier this year, I and many people who follow developments in Congress predicted that Congress would extend the $3,500,000 exemption for years to come. Most estate tax commentators saw the $3,500,000 exemption as the logical answer.

Impact of New Spending. What has changed so soon? Look at some numbers from the Heritage Foundation report of July 2009:

*Spending Surging. Spending and deficits are surging at a pace not seen since World War II.
*$33,932 per household. Washington will spend $33,932 per household in 2009 which is an increase of $8,000 from 2008.
*2008 Deficit $466 B. Federal spending was $3,031 billion in 2008 with a deficit of $466 billion.
*2009 Deficit $1,845 B. Federal spending in 2009 will be $4,004 billion with a deficit of $1,845 billion.
*Large Deficits Through 2019. Federal Spending is projected to continue to exceed revenue by a large gap through 2019.
*32.1% Jump in 2009. Federal spending grew by 4.9% in 2008 and by 32.1% in 2009.
*Spending Will Stay High for 10 years. President Obama’s budget proposal has per household spending at $33,392 in 2009 and ten years later in 2019 at $33,312, indicating a continuing high level of spending.
*Annual Increase is 8%. Since 2001, spending has increase at an average annual rate of 8%. If this rate continues for the next ten years, there will be massive requirements for new revenue.
*Social Spending To Consume All Taxes. By 2050, spending just for Social Security, Medicare and Medicaid will consume all of the federal taxes that the federal government usually collects as a percentage of the economy.
*Massive Tax Increases Needed. To just pay for Social Security, Medicare and Medicaid, taxes will have to increase from less than $1000 per household in 2010 to $3,000 by 2020 and over $12,000 per household by 2050.
*Spending Increases without 2009 Problems. This spending is not temporary and will continue to increase even without the global war on terror, the 2009 financial bailouts and the 2009 stimulus bill.
*Popular Programs Rapid Increase. Spending on popular programs is growing rapidly.
*Education up 169%. K-12 spending has surged 169% since 2001.
*Veteran Spending Doubled. Veteran spending has doubled since 2001.
*Medicare up 68%. Medicare Spending has jumped 68% since 2001.
*Interest Will Consume 2/3s of Deficit. By 2019, net interest costs will be two thirds the size of the entire budget deficit.

Looking for Found Money. Congress is considering cap and trade and health care legislation which involve large tax increases. There is a major search by Congress through the tax code for ways to pay for desired projects and plans. Most plans target the “wealthy” for increased taxes.

Do Nothing and Get an Automatic Tax Increase on the Rich. An obvious target: Do nothing, and by law, the exemption for estate taxes will be $1,000,000 with rates as high as 55% in 2011. The estate taxes do not generate much revenue, but given what is happening, even a few measly $100 billion extra here or there might help pay for parts of a few programs.