06 July 2006

A Better Estate Tax Compromise

Senator Mary L. Landrieu (D-LA) has introduced S. 3626, which "would set the exemption at $5 million ($10 million for a married couple), impose a 35% flat rate, and provide special valuation rules for family businesses and farms to be valued." Landrieu's bill also has a 5% bubble rate to phase out the exemption, which kicks in at $100,000,000. The special use valuation cap goes from $750,000 to $5,000,000, and the family owned business exclusion goes from $675,000 to $2,500,000. The 35% tax rate reflects the philosophy that the estate tax is really a tax in lieu of an ordinary income tax on inheritance income.

Thus, at $5,000,000 the tax is $0, at $30,000,000 the tax is $8,750,000, at $105,000,000 the tax is $35,000,000, at $140,000,000 the tax is $49,000,000, and at $240,000,000 the tax is $84,000,000 under S. 3626.

This bill is superior to H.R. 5638 which recently passed the House.

[H.R. 5638] would establish an exemption amount for gift and estate taxes (and also for the generation skipping transfer tax) of $5 million per person per lifetime, and surviving spouse could elect to use any unused exemption of a deceased spouse, something not possible under current law which is a basis for a great deal of estate planning activity.

The firsts $25 million would be taxed at the maximum capital gains tax rate(currently 15%, set to increase to 20% in 2011 unless extended) and the balance would be taxed at twice that rate (currently 30%, set to increase to 40% in 2011 unless extended).

Thus, assuming the higher capital gains tax rates, at $5,000,000 the tax is $0, at $30,000,000 the tax is $5,000,000, at $105,000,000 the tax is $35,000,000, at $140,000,000 the tax is $49,000,000, and at $240,000,000 the tax is $89,000,000 under H.R. 5638.

This means that if the top capital gains tax rate is restored to 20% that for estates of less than $105 million, S. 3626 collections somewhat more, while for estate of more than $140 million, H.R. 5638 collects slightly more revenue. In between, the bills collect the same amount of revenue if capital gains rates are restored to 20%.

On the other hand, if capital gains tax rates are not restored to 20%, then S. 3626 will collect more revenue for all estate sizes, except for a few estates with small business or farm assets, which are singled out for more favorable treatment under S. 3626.

Notably, Senator Frist's threat to bring a bill to the floor before the 4th of July flopped. The Washington Post also notes the virtues of rethinking the estate tax as an inheritance tax. This is certainly the best theoretical basis for the tax, even though it may be slightly more burdensome in practice to administer.

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