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Congress Debates the Fiscal Cliff:

What Happens to Estate Taxes?
The Washington Update
By Andy Friedman
November 27, 2012

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The estate and gift tax exemptions are scheduled to fall and the estate tax rate to rise if Congress does not address them during the current lame duck session. This update discusses what is likely to happen this month and next year as Washington develops proposals for tax reform.

Before we get to the update, though, a few television announcements.

  • Last week, I discussed the fiscal cliff deliberations in Congress on China Central Television. The discussion was shown live in China. You can access the segment by clicking here.
  • In the cover story for this month's Forbes magazine, I discuss my predictions for the fiscal cliff deliberations and how investors will be affected. You may access the article by clicking here.
  • Today (Tuesday) I will be appearing on CNBC's Power Lunch, which begins at 1 pm est. I will circulate a link to the video after that appearance.


Since mid-2011, I have said that the real action in Washington in 2012 will take place after the election, when Congress and the President must address the looming expiration of the Bush tax cuts. That time finally has arrived.

The dislocation caused by the tax cut expiration is joined with spending cuts slated to take effect under last year’s compromise to raise the federal borrowing limit. If both occur, the higher taxes and lower spending are projected to throw the economy back into recession for at least the first half of 2013. An Update to the Budget and Economic Outlook: Fiscal Years 2012 to 2022, Congressional Budget Office (August 2012). The financial community has dubbed this effect “the fiscal cliff.”

Although the bulk of the fiscal cliff debate is focused on the income tax, the estate tax comes into play as well. Currently (in 2012), the combined lifetime estate and gift tax exemption is $5.12 million per person, and the estate tax rate is 35%. If Congress does not act, in 2013 the combined estate and gift tax exemption drops to $1 million and the estate tax rate rises to 55%. To the extent an investor uses his lifetime gift tax exemption, he is not permitted to use that portion of his estate tax exemption when he dies. Essentially, by making the gift, he is accelerating his estate tax exemption and using it during his life. Doing so may make sense because the gift can appreciate during the remainder of the donor’s life and the full value at death is entirely free of estate tax.

I don’t believe that most members of Congress want to return to a $1 million estate tax exemption. Even the Democrats (who typically are less concerned about higher taxes on the wealthy) believe a $1 million exemption could require too many forced sales of family farms and businesses upon death to pay estate taxes. Similarly, both parties seem to feel a 55% tax rate on estates is too high. President Obama has proposed a $3.5 million estate tax exemption and a 45% rate. If a deal is reached on taxes generally (either by year-end or retroactively after the new Congress convenes in January), that deal is likely to include an estate tax exemption somewhere between $3.5 million and $5 million, and a 45% estate tax rate.

Where the gift tax exemption ends up is less clear. Although Democrats believe a higher estate tax exemption is needed to keep family businesses intact for future generations, many do not see the need for a high gift tax exemption, which they view as a loophole allowing the wealthy to transfer significant assets tax-free during life. Thus, a final deal could “decouple” the estate and gift tax exemptions (the situation that prevailed until 2011), and leave the gift tax exemption at $1 million.

If and when a deal is reached, Congress also is likely to extend the “portability” rules currently in effect but scheduled to expire at year end. These rules allow one spouse to use any estate tax exemption not used by a previously deceased spouse. This rule, too, is relatively non-controversial.

On the other hand, both the President and members of the Congressional tax-writing committees have proposed curtailing some sophisticated wealth transfer techniques, such as intentionally defective grantor trusts (IDGTs), grantor retained annuity trusts (GRATs), and family limited partnerships (FLPs). For instance, President Obama’s budget proposal, released last February, would require a ten-year minimum term for GRATs and would include in an estate assets held in a trust the income of which is taxed to the donor. Due to their complexity, Congress is unlikely to include these changes in legislation passed to address the fiscal cliff. More likely, these changes will be included in tax reform legislation to be considered next year. Any such changes presumably would not apply to assets transferred prior to the effective date specified in the law, although this result cannot be guaranteed.

One final point. Although President Obama seems determined to extract more income taxes from affluent taxpayers, his public pronouncements have been much less focused on the estate tax. Thus, there is a possibility he might agree to extend the current estate and gift tax rules in exchange for Republican concessions to raise the income tax. Given his stated determination to impose his election “mandate,” of course, such a result is far from assured.


Andrew H. Friedman is the Principal of The Washington Update LLC and a former senior partner in a Washington, D.C. law firm. He speaks regularly on legislative and regulatory developments and trends affecting investment, insurance, and retirement products. He may be reached at

Neither the author of this paper, nor any law firm with which the author may be associated, is providing legal or tax advice as to the matters discussed herein. The discussion herein is general in nature and is provided for informational purposes only. There is no guarantee as to its accuracy or completeness. It is not intended as legal or tax advice and individuals may not rely upon it (including for purposes of avoiding tax penalties imposed by the IRS or state and local tax authorities). Individuals should consult their own legal and tax counsel as to matters discussed herein and before entering into any estate planning, trust, investment, retirement, or insurance arrangement.

Copyright Andrew H. Friedman 2012. Reprinted by permission. All rights reserved.


(c) Andrew H. Friedman



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