Estate Tax Repeal Defeated.

The Senate failed to end a filibuster of an estate tax repeal effort. The vote was 57-41. Four Democrats joined all but one Republican, Voinovich from Ohio, to force a vote on the issue. Two Democrats didn't vote. Sixty votes were required.

This leaves us with the status quo. Now, each person can leave $2,000,000 to heirs at death or in large lifetime gifts combined. The estate pays a 46% tax on the rest. The rate falls to 45% for 2007-2009. The exemption increases to $3.5 million in 2009.

In 2010, the estate tax is abolished. But in 2010 current law, which forgives accrued taxes on unrealized capital gains at death will be replaced by a provision that limits that boon to the first $1.3 million of assets in an estate (subject to certain exceptions) with the rest taking a "carryover basis" meaning heirs will have to pay taxes on capital gains accrued during the decedent's life if the assets are sold. In 2011, the exemption returns to $1 million and the rate goes back up to 55% plus a 60% "bubble rate."

The gift tax remains on the books for this entire period with a $1,000,000 and a nominal tax rate identical to the estate tax (effectively, it is about a third less due to the way it is calculated). The gift tax rate in 2010 will be 35%.

This is a horrible mess, so everyone expects that further negotiations will take place. But, this may not happen until after the 2006 election. The GOP wants a campaign issue.

One Republican proposal being considered by Senate negotiators would drop the rate to 15% and increase the exemption to $5,000,000. Democratic Senator Baucus, who voted for cloture in exchange for a promise to have his proposal considered as an amendment, would have had graduated rates of 15%, 25% and 35% apply to estates.

Another possibility, one that doesn't seem to have much Republican support, as they want to go further, but might attract support if the composition of the Senate changes in November in the Democratic party direction, might be to freeze the estate tax at 2009 levels, i.e. a 45% tax rate and a $3,500,000 exemption, perhaps accompanied by indexing of the exemption amount and increasing the gift tax exemption to match the estate tax exemption.

No one really expects the law to run its course all the way to estate tax reinstatement in 2011, but in the face of massive deficits and deep partisan divides over the issue, it is hard to say. Needless to say, this makes estate planning difficult with the law just six years in the future hopelessly muddy.