Heirs who come into big money after the federal estate tax expires at the end of the month might want to hold off spending it.
The Senate rejected a bill Wednesday to extend the estate tax for two months while lawmakers work on a more permanent solution. Majority Democrats, however, vowed to come back from their holiday break early next year and pass an extension, and several key lawmakers said they would make the tax retroactive to the start of the year.
The uncertainty is already causing problems for tax planners.
"You certainly have clients who may have a few months to live, and they need to get their affairs in order," said Charles Schultz, director of private wealth and tax advisory services at the accounting firm RSM McGladrey. "It makes it difficult to plan."
This year, the inheritance tax is 45 percent on estates larger than $3.5 million. Estates smaller than $3.5 million are exempt from the tax, and married couples, with a little estate planning, can exempt a total of $7 million. That leaves less than 1 percent of all estates subject to the tax.
Under current law, the federal estate tax is scheduled to temporarily disappear next year before returning in 2011 at an even higher 55 percent rate. However, during the year without an estate tax, many estates would be subject to a 15 percent capital gains tax that they now avoid.
Sen. Max Baucus, D-Mont., called it "the yo-yo effect."
"It is an outrage," Baucus said, "that the Congress allows estate taxes to change so much."
Baucus, who chairs the tax-writing Senate Finance Committee, proposed a two-year extension of the current estate tax while lawmakers "get our act together to determine what estate tax law should be." But under Senate rules, lawmakers couldn't take up the bill unless all senators agreed.
Senate Republican Leader Mitch McConnell of Kentucky objected, saying he wanted to extend the tax at a lower rate that would exempt more estates from the tax. McConnell proposed a 35 percent estate tax that exempted estates smaller than $5 million, in line with language the Senate adopted in drawing up a budget deal last spring.
"There's nothing that outrages the American people more than the thought that they will have to visit the IRS and the undertaker on the same day," McConnell said.
Baucus balked at McConnell's offer but said lawmakers will act early next year to deny heirs of multimillionaires an inheritance tax holiday in 2010.
The quirk in the law, in which the estate tax would disappear for only a year, came out of a series of tax cuts enacted in 2001. Many Republicans, who controlled Congress at the time, wanted to permanently repeal the estate tax then. But they settled on a gradual reduction, with a one-year repeal, to reduce the impact on the federal budget deficit.
"This chicanery has created a nightmare for families trying to plan their affairs," said Senate Majority Leader Harry Reid, D-Nev.
Two weeks ago, the House passed an indefinite extension of the estate tax at the 2009 rates. Since then, House Democrats have proposed a variety of shorter extensions, ranging from two months to a year. The Senate, however, has not been able to come up with enough votes to support any of the proposals.
"I have every confidence it will be fixed early next year," said Rep. Earl Pomeroy, D-N.D., who wrote the House-passed bill extending the 45 percent inheritance tax rate.