Return of Estate Tax Looms as Final Impediment to Extending Bush Tax Cuts

Ending the uncertainty over extending Bush-era tax cuts may rest on resolving a decade-long debate over death and taxes.

The federal levy on estates is set to increase the most of all as tax cuts expire Jan. 1, jumping from zero to 55 percent for fortunes worth more than $1 million at death. President Barack Obama and Democrats in Congress barely mention it as they spar with Republicans over whether to keep income-tax reductions for top earners.

A new tax on multimillion-dollar estates may emerge as the final hurdle to a deal that preserves most or all of former President George W. Bush’s tax cuts, analysts said. Congress has unsuccessfully sought at least a half-dozen times to resolve the issue since 2000, including an abandoned effort last December to prevent the estate tax’s expiration.

“The history on the estate tax is every time there’s almost an agreement someone leaves the table in the belief they’ll get a better deal next time,” said Clinton Stretch, a managing principal at the Washington consulting firm Deloitte Tax LLP.

With Obama planning to meet with bipartisan congressional leaders at the White House tomorrow, three main factions have formed in the Senate, none of which has the 60 votes needed to advance an estate-tax proposal. One includes Republicans such as South Carolina’s Jim DeMint who favor permanent repeal. Another is led by Democrats including Majority Leader Harry Reid who support a top rate of 45 percent that would apply after a $3.5 million tax-free allowance.

Moral Issue

A third faction, led by Arizona Republican Jon Kyl and Arkansas Democrat Blanche Lincoln and embraced by Republican leader Mitch McConnell of Kentucky, backs setting the top rate at 35 percent after a $5 million exemption.

Forging an agreement has proven more complicated than splitting the difference on the numbers because this has been cast as a moral issue, said Lee Farris, senior organizer on estate-tax policy for United for a Fair Economy, a Boston-based group that advocates reinstating the estate tax.

Opponents criticize the estate tax as an unfair levy that destroys family businesses while proponents of the tax, who include billionaires Warren Buffett and Bill Gates, view it as essential to preserving meritocracy in U.S. society. That argument has gained steam this past year with the deaths of at least five U.S. billionaires, including New York Yankees owner George Steinbrenner.

“People are more dug in on their estate-tax positions on both sides than they are on the other positions,” Farris said.

Central Feature

The one-year repeal of the tax in 2010 was a central feature of the Bush tax cuts. It was repealed for only one year because a deal made in 2001 between Republicans and deficit-wary Democrats gradually reduced the tax through 2009 before it was repealed. The same bargain placed the Dec. 31, 2010, expiration date on all of the 2001 and 2003 tax cuts with which Obama and Congress are now wrestling.

The repeal also was the pinnacle for business groups and anti-tax activist organizations such as the American Family Business Institute and Americans for Tax Reform.

In the past year trade groups such as the National Federation of Independent Business and the National Association of Manufacturers, alarmed by the possibility of a 55 percent rate in 2011, have pivoted toward urging lawmakers to adopt the approach favored by Kyl and Lincoln. Though Lincoln lost her bid for re-election on Nov. 2, she says she still backs the proposal to set a top rate of 35 percent after a $5 million exemption.

Separate Laws

The business groups have been frustrated with a sequence of three separate estate-tax laws starting in 2009, when the first $3.5 million of an individual’s estate passed to heirs tax-free before a 45 percent rate kicked in. The Congressional Research Service says using those parameters in 2011 would subject 0.25 percent of U.S. estates to any tax in 2011 and generate $18.1 billion in revenue.

By contrast, a 55 percent top rate, with a $1 million exclusion, would affect 1.76 percent of estates and generate $34.4 billion in revenue, the CRS said. That’s enough to fund the departments of Labor and State. The Kyl-Lincoln approach would subject just 0.14 percent of estates to any tax and generate $11.2 billion, according to the CRS.

The anti-tax groups say they will continue to pressure lawmakers for repeal.

“What we would very much like to see is an extension of death taxes where they are right now, see an extension of the zero rate,” said Dick Patten, president of the group founded by Alabama lawyer Harold Apolinsky and funded heavily by investment banker Raymond Harbert, the son of a billionaire heiress.

The group refers to the levy as the “death tax,” even though 99 percent of U.S. residents don’t accrue a large enough fortune in their lifetime to pay it.

Most lawmakers likely will be wary of setting a tax-free allowance at $1 million, when it was $3.5 million only a year ago, said Jade West, a lobbyist for the National Association of Wholesaler-Distributors. “It doesn’t take a lot to get to a million.”

To contact the reporter on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net.

To contact the editor responsible for this story: Mark Silva at msilva34@bloomberg.net

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