On January 1, 2010, the federal estate tax is set to disappear, but come the following New Year, the estate tax rules that had been in effect prior to 2002 are set to reappear. This would mean a top tax rate of 55% and an exemption of only $1 million (it’s $3.5 million in 2009). This week the House will be voting on a bill (H.R. 4154) that would freeze the estate tax at 2009 levels (a top rate of 45% and an exemption of $3.5 million per person with no indexing for inflation). The key questions that Congress should be asking are whether we need a federal estate tax at all and what the impact retaining the estate tax will have on small business and the economy.
The federal government is always in need of revenue, but how much revenue does the federal estate tax add to the coffers? According to the Office of Management and Budget (tables 2.1 and 2.5), the estate and gift taxes account for only about 1% of total revenues, a rate that’s remained fairly constant for many years. Being a revenue raiser is a poor argument for retention of the estate tax.
Impact on small business owners
The estate tax can have an adverse affect on small businesses. When an owner dies, the federal estate tax on the value of his or her estate is due nine months after death. Some businesses are forced to sell off interests, often at fire sale prices, to raise the capital needed to cover the tax bill. Others carry costly life insurance to provide liquidity for the tax bill. There is some relief for estates consisting of certain business interests, where the estate can elect to spread over a period of up to 14 years. In any event, owners often incur considerable estate planning fees to devise tax strategies for passing on the business to the next generation.
Some experts, such as the senior policy analyst at the Heritage Foundation, suggest that repeal of the estate tax would have a positive impact on the economy. The estate tax is viewed by some as a tax on capital and such tax impedes job creation and capital investments. If this is so, then now would seem the appropriate time to eliminate the estate tax entirely so that jobs can be created and capital investments made to spur the economy.
Those in favor of an estate tax maintain that it is only “fair.” The question should be asked: fair for whom? The families of people who create the businesses? The workers of these businesses who could lose their jobs?
Hopefully Congress won’t be guided by a misperception of fairness and will make law based on revenue and reason.
Caution: Small business owners should not be quick to cash in life insurance policies, tear up buy-sell agreements, or otherwise dash their estate plans. Many states continue to impose death taxes, and will probably do so regardless of any federal estate tax change.