Relief in Estate and Gift Taxes?

The prevailing tenor in Washington to enact some sort of tax relief before the end of the year appears to bode well for a reduction in the estate and gift taxes now levelled against family and other closely-held businesses.

A House Republican bill (HR 1215) recently approved as part of the “Contract with America,” provides for an increase in the unified credit from $600,000 (per individual/spouse) to $750,000, to be phased in over a three year period, beginning with $700,000 the first year and ending with $750,000 in the third.

The projected revenue loss from such an increase, however, has been estimated at $6.8 billion over a five year period, rising to approximately $22 billion over the next ten years ending in 2025. As a result, both Congress and the Treasury have begun to focus on “more targeted relief” in the estate tax arena that would reduce revenue losses below that of the House-passed measure.

But, according to Dirk R. Dreux, IV, a Vice President with U.S. Trust Co., “the amount of money that estate and gift taxes actually contribute to the federal budget annually is less than one percent.” Furthermore, he noted, studies by the Tax Foundation suggest that approximately 65 percent of every transfer tax dollar raised is used for administrative and/or legal purposes, either to collect, monitor, or otherwise administer the tax collection process. “This is not the era of the trust busters where excessive concentrations of wealth and political influence were prevalent,” Dirk Dreux said, adding, “when you think about the fact that income mobility in the United States is so high, then the tax does not make any sense at all.”

The “targeting,” of relief, Don Scotto of Coopers & Lybrand said, can actually mean bigger estate tax relief for certain types of businesses. He called family owned and closely-held businesses the one common denominator in the movement for targeted estate tax relief. Relief for family owned businesses, Scotto noted, is gathering momentum among congressional leaders with current initiatives ranging from a total repeal of the estate tax – not likely this year – to a more focused reduction.

The House bill, only one of several being circulated, makes no changes in the existing tax rate schedule under which estate and gift taxes are computed based on cumulative lifetime transfers and transfers at death. Current rates begin at 18 percent for taxable transfers over $10,000 and increase to a maximum of 55 percent on cumulative transfers between $10 and $21 million. Taxpayers, however, may gift, tax free, up to $10,000 per individual during any calendar year.

A senate measure by Sen. Thad Cochron (R-MS) which, like the house bill, does not change the existing tax structure, does provide for an additional credit value up to $400,000 of “family enterprise property.”  This would allow certain taxpayers to transfer, tax free, up to $1 million in property.

“Family enterprise property” is defined as property used for farming or any other trade business if at least 80 percent of the ownership is held by no more than five individuals, or individuals who are in the same family. The property, however, must continue to be actively used in the trade or business for a ten year period after the death of the decedent to qualify. The Cochran bill also provides for an additional $10,000 in tax free gifting of “family enterprise property” per individual in a calendar year.

Another senate measure, this one proposed by Patricia Murray (D-WA), would in certain cases, limit to 15 or 20 percent the estate tax rate on “qualified family business interests,” described as: “a) any interest in a sole proprietorship, b) a partnership carrying on a trade, or c) a business with 15 or fewer partners, and/or a corporation with 35 or less shareholders.” The bill also requires that the value of the business interest must exceed 50 percent of the value of the adjusted gross estate, and that pre-death active participation and post-death continuity of interest are met.

The Murray bill also provides for the application of a special four percent interest rate to be available for taxpayers deferring payment of estate taxes, without regard to the present $1 million IRS limitation. In addition, the measure would allow an alternate valuation date of 40 months (as opposed to the current 6 months) after the decedent’s death to be utilized by estates that qualify for the reduced tax rates. And, finally, under Murray’s bill, the annual exclusion for gifts may not be less than 15 percent of the donor’s earned income during the calendar year with the unified credit indexed for inflation.

Presidential hopeful, Sen. Robert Dole, reportedly favors a proposal that would change the current tax rate for certain “qualified family owned businesses” that are conveyed to qualified heirs. As such, the maximum estate and gift tax rate would not exceed 30 percent.

“Qualified family owned businesses” are described as those which: comprise more than 50 percent of the gross estate, are not publicly traded, are owned by 15 or fewer individuals, and whose decedent’s family owns and controls the majority equity. Qualified heirs include members of the family and active employees in the business. The Dole-supported measure makes no other changes to the existing estate and gift tax law.