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Will the Estate Tax Become the Next AMT?

Joanne S. Barry

The estate tax is not something most taxpayers need to worry about. According to an article in U.S. News & World Report, the estate tax affects less than 5% of Americans. But if Congress fails to act soon, the estate tax could become the next alternative minimum tax (AMT)—another patchwork piece of the U.S. tax code aimed at wealthy taxpayers but transformed by years of partisan lever-aging and congressional inaction to instead affect the middle class.

As a result of sunset provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 that many did not expect to take effect as scheduled, the estate tax expired in 2010 but is slated to return to pre-law levels in 2011. That year, those who inherit an estate valued in excess of $1 million will be taxed at 55% unless Congress acts to change the law. This abrupt repeal and reinstatement has led to a host of issues that Congress has yet to resolve.

The estate tax makes up only a small fraction of overall federal revenues. In the eyes of many, it is not intended to raise revenue but to prevent the rise of an American aristocracy by breaking up vast concentrations of intergenerational wealth. But we're applying old notions to new generations of Americans who can hardly be considered an “aristocracy.” Today, $1 million is not a vast concentration of wealth begging to be broken up. In the very near future, between the aging of baby boomers and the prospect of inflation, more middle-class Americans will be caught in the estate tax net. Like the AMT, the spirit of the law could be violated by Congress's inability to keep the law consistent and up to date.

The entrepreneurial spirit of the baby boomer generation led to the creation of innovative businesses and an expansion of the middle class. These successes awarded many of this generation a desirable quality of life—they could own their own homes, send their kids to good schools, and save for a comfortable retirement. These are not the superrich, those who own sprawling manors on huge tracts of land, for whom this tax was originally created.

Should Congress not act by January 1, 2011, when reversion to the old rates and exclusion are scheduled, the effects on families and small businesses will be significant, especially during this weak economy. While a 2005 Congressional Budget Office report noted that the vast majority of estates had enough liquid assets to pay the estate taxes they owed, estates involving farms or small businesses were less likely to have sufficient liquid assets to cover their estate taxes. According to the report, in 2000, about 8% of the estates of farmers who left enough assets to owe estate taxes faced a tax payment that exceeded their liquid assets, compared with about 5% of all estates that owed taxes. For estates claiming the Qualified Family-Owned Business deduction, the corresponding figure was about 34%, according to the report.

Creeping Problems

Legislative inaction concerning the estate tax may already be harming the middle class. When the estate tax expired on January 1 of this year, so did the step-up in basis rules on inherited assets, meaning that if you inherited a $2 million home from your mother and sold it, you'd have to pay a 15% capital gains tax based on the price your mother paid for the house, not the value of the home on the day your mother died. An exemption exists for the first $1.3 million in capital gains, but this applies to all assets sold, not just a home.

In the meantime, families and their CPAs wait in limbo. Without a clear idea of how the landscape will look next year—if it will be shaped by the old law, a new law, or something else entirely—no one knows how to prepare. The situation has created significant uncertainty and confusion for CPAs and their clients. People don't know how they should plan their estates, prepare their wills, or divide their assets.

Estate planning has become a minefield, and one misstep can cost a client hundreds of thousands, or millions, of dollars. CPAs need to know what to expect so they can continue to provide quality service to their clients. And time is running out. Regardless of whether inheritances will be taxed at 45% or 55%, whether exclusions will be $1 million or $3.5 million, executors will still need to move quickly—payment is still due nine months after receiving an inheritance.

The public needs decisive, forward-looking legislation from Congress on the estate tax. What the public does not need is another AMT that does nothing but strike fear into middle-class taxpayers before political posturing results in a patch that does nothing to fix the fundamental problem for future generations. That's an inheritance no American should have to pay for.

Joanne S. Barry. Acting Executive Director. The CPA Journal.

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