Estate Tax in Limbo

Here’s a case example that illustrates the confusion regarding the 2010 unlimited estate tax exemption.

I’m representing a client who is a beneficiary of an estate worth in excess of $100,000,000. My client will receive a portion of the estate. The problem is estate taxes, or more precisely, lack of estate taxes…maybe. Let me explain.

In 2001, President Bush signed into law Internal Revenue Code Section 2001 which both increased the estate tax exemption AND reduced the estate tax rate. Estate Taxes are calculated by subtracting the estate tax exemption from the fair market value of the estate, and multiplying that by the estate tax rate.

For example, in 2007, the estate tax exemption was $1,500,000 and the estate tax rate was 45%. If a person died with a $3,500,000 estate, the taxable estate would be $2,000,000 ($3.5m estate less a $1.5m exemption) with a $900,000 estate tax ($2,000,000 taxable estate multiplied by 45%. However, in 2009, when the estate tax exemption was $3,500,000, there would be no estate tax, since the exemption covered the entire estate value.

In 2010, there is technically no estate tax, because the exemption is unlimited. However, it is widely speculated that the estate tax exemption will be put back to $3,500,000, retroactive to January 1, 2010. What does this mean in my client’s case?

Well, if the estate is worth $100,000,000, then with an unlimited estate tax exemption, the estate tax is zero. If the estate tax exemption is $3,500,000, the taxable estate is $96,500,000. The estate taxes due would be about 45% of that amount, or $43,425,000. Big difference!

You might wonder about the legitimacy, of a retroactive estate tax. Well, I certainly feel that this case could likely wind up in court to determine whether a retroactive estate tax is indeed enforceable. While I think this type of assessment is unconstitutional under the due process clause, there is also authority in the IRS’ favor, namely the 1993 Supreme Court case of U.S. v. Carlton, in which the Supreme Court upheld a retroactive assessment of a tax because it was “rationally related to legitimate legislative interest”, namely raising revenue. I think this was the court’s way of saying that they would permit any retroactive tax. However, the makeup of the Supreme Court has changed substantially since 1993, and I would not be surprised if a different result was reached. We’ll see what happens in this case.