Planning Required to Reap Full Benefit of Proposed Estate Tax Deal

The primary focus of extending the Bush-era tax cuts has been to spare Americans a tax hike at the end of the year. But the proposed estate tax that raises the limit on assets that can be protected from taxation is getting increased attention and threatening to derail the two-year deal crafted by President Obama and Congressional Republicans.

President Obama and the Republicans agreed to impose a 35 percent federal tax on assets transferred after an owner’s death, while allowing benefactors to exempt up to $5 million of the value of an estate. House Democrats voted Thursday to not bring the bill up for a vote unless some changes are made but didn’t say what they wanted changed.

While many Democrats believe they will have to extend the Bush-era tax cuts for the wealthy to protect middle-class taxpayers, they say the concessions on estate taxes go too far given that current law calls for the new estate tax rate to be as high as 55 percent with just $1 million in exemptions.  The Associated Press reported that House Speaker Nancy Pelosi called the proposed estate tax provision, “a bridge too far.”

Nonetheless, the deal still may pass because of significant Republican support. If passed, the law could have a significant impact on business owners in the very fragmented accounts receivables management industry.

Kaulkin Ginsberg Director Michael Lamm said 95 percent of the industry’s collection agencies are owner-operated businesses with 10 or fewer full-time employees. The death of one or more owners could present huge tax consequences for the remaining partners and their families without proper tax planning. In some cases, it could keep heirs from leading the family business if they have to sell it to pay estate taxes. However, proper tax planning can’t be done without proper asset valuation.

“You need to have some idea of the value of your company to determine what your estate planning needs will be,” Lamm said. He added that if an ARM business owner dies without some indication of the company’s value, the courts will have to have it valued, potentially costing both the business and owner’s family more money in taxes and expenses associated with settling the estate.

Tax experts say the proposed higher exemption limit of $5 million per spouse could benefit a lot of small business owners. But the exemptions have to be structured properly with the help of an estate planning attorney or consultant to achieve the maximum benefit allowed, said Eric Larson, a Wichita, Kans-based tax attorney.

“You have to do some planning to take advantage of the exemption for each (spouse),” Larson said.

Theoretically, the proposed tax deal is better for collectors of consumer debt owed by the deceased, too said Jennifer Lee, president of Baltimore-based Estate Recoveries, Inc. Before the estate tax expired in 2009, $3.5 million of decedents’ net assets after expenses were exempt from taxation. Anything more was taxed at 45 percent.  The proposed rate also is significantly better than the rates and exemptions that would take effect January 1, 2011 if lawmakers don’t act.

“If the limit is increased, the personal exemption is increased,” Lee said, adding that the proposed might leave decedents’ estates with more assets that are protected from taxes. Those assets can be used to pay their debts. But Lee noted that few deceased debt collections involve people with millions in assets.

Heirs of wealthy business owners who died this year avoided an estate tax for the first time since World War I because it had been allowed to expire last year, said Curtis Dubay, a senior tax policy analyst with the Heritage Foundation.

Many Democrats would like to see the estate tax rate return to at least the 2009 levels. Republicans, meanwhile, would prefer that the “death tax” be permanently repealed.

Although less than one percent of Americans pay the tax, it can generate billions for the federal government. According to the Internal Revenue Service, the number of estate tax returns filed decreased from more than 108,000 in 2001 to fewer than 34,000 in 2009 because of increases in the threshold limit. The estates combined tax obligation after deductions was nearly $21 billion.

Even though some portion of future decedents’ estates could be taxed up to 55 percent next year if the proposal doesn’t pass, Dubay said he doesn’t see Republicans compromising further on the estate tax proposal.

“If anything passes this is it,” he said.

That’s likely the case even if lawmakers don’t act until next year when Republicans control Congress and have enough seats in the Senate to filibuster any proposal they don’t like, Dubay said. Heirs, however, won’t avoid all taxes in 2010.  A 15 percent capital gains tax is due on all assets sold for more than they are worth. Capital gains taxes affect everyone, regardless of income.