Estate Tax Changes Verge on the Absurd

WASHINGTON ( TheStreet) -- The estate tax Congress delivered last month should exist only in a parallel universe.

The problem is that this law, which creates structural changes and introduces needed concepts, is only temporary. We need permanence to provide stability and enable long-term planning.

A good catch for a wealthy widow? Even if he's penniless, this man's estate tax exemption might be worth $1.75 million.

Will Laffer have the last laugh?
The new law reduces the maximum estate tax rate to 35% and increases the exemption equivalent to $5 million for lifetime gifts and estates. This law "sunsets" in 2012, though. After that, the top estate tax bracket will go back to pre-2001 law, with a 55% maximum rate and an exemption of $1 million.

Arthur Laffer's "Laffer Curve" explained how lower tax rates can result in higher tax revenue. Higher exemptions and lower rates decrease the incentive for estate planning, mitigating the loss of revenue. Because this law is temporary, though, the imminent return of higher rates and lower deductions actually increases the incentive for couples with assets over $2 million to do as much estate planning as possible now.

This represents a lost opportunity for Republicans who favor lower rates and Democrats who want the rich to pay higher taxes, and for both who would like to reduce the deficit.

Exemptions "momentarily" indexed to inflation
In a nearly meaningless move, the law indexes the $5 million estate tax exemption to inflation after this year. Because the law expires at the end of 2012, this will help only the estates of those dying that year. Indexing is a logical concept, and it works well in many areas of the tax law. This provision should have been made permanent.

The portability myth
A while back we wrote about "portability" -- which means that even if the exemption of the first spouse to die is not captured in a trust, the surviving spouse's exemption increases by the same amount. A well-written portability provision would level the playing field between those who pay a lawyer for a complicated trust and those who don't.

Once again, because this law expires at the end of 2012 and the law that will come into effect doesn't recognize this concept, both spouses have to die before 2013 for this to apply.

Return of the "black widow" rule?
One interesting twist in the new law provides that the surviving spouse may inherit the other's entire $5 million exemption even if the first spouse has no assets! That's right: An elderly widow might marry an even more infirm pauper just for his tax benefits! We can't wait to see who takes advantage.

To prevent serial tax-related marriages in nursing homes, Congress allows portability only from the most recent spouse of a decedent. Doubling up is still possible if the first spouse to die puts their exemption equivalent in a trust.

We don't foresee anyone tearing up the trusts incorporated into their current estate plans.

Good news for the comatose?
We've read much about "death elasticity" -- the theory that deaths among the wealthy increase on the eve of an increase in the estate tax. Because this law softens the impact of waiting another day, you might want to reconsider pulling the plug on dear old dad by Dec. 31 just to avoid the estate tax.

-- Reported by William Baldwin in Waltham, Mass.

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