Federal Estate and Gift Taxes:
The Positions of Senators McCain and Obama and
Other Proposed Legislation

by Joy D. Wilman

The Federal Estate Tax
The federal estate tax, a tax on the right to transfer property at an individual's death, is imposed on the individual's estate.  The property subject to the estate tax generally includes all assets that the individual owns or controls at the time of death and may consist of cash and securities, real estate, insurance, certain trusts, annuities, business interests and other assets.
 
Under current law, each individual is granted an exemption from the federal estate tax for the first $2 million of taxable assets.  If the taxpayer's taxable estate exceeds this amount, the excess assets are subject to a flat 45% federal estate tax.  It is important to note that transfers between spouses and distributions to charities are typically free from the estate tax.  In 2009, the $2 million exemption is set to rise to $3.5 million, with the estate tax rate remaining at 45%.  In 2010, the federal estate tax is scheduled to disappear completely, only to return again in 2011 with a reduced exemption amount of $1 million.

Senator McCain proposes increasing the exemption in 2009 from $3.5 million to $5 million ($10 million per married couple with proper planning) and cutting the tax rate from 45% to 15%.   Senator Obama proposes maintaining the exemption at $3.5 million ($7 million for married couples with proper planning) and maintaining the 45% tax rate on estates worth more than $3.5 million.  Neither candidate supports a permanent repeal of the estate tax as President Bush has proposed.   Both candidates support adjusting the exemption for inflation.

The Federal Gift Tax
The federal gift tax is a tax on the transfer of any property by an individual during the individual's  lifetime to another while receiving nothing, or less than full value, in return.  The gift tax applies whether or not the donor intends the transfer to be a gift.  Beginning in 2002, the lifetime gift tax exemption, which previously mirrored the estate tax exemption, was fixed at $1 million, and the gift tax rate was set to be identical to the estate tax rate.  By January 2009, the maximum gift tax rate is scheduled to decrease to 35% under the rules currently in place, but this may change.  Use of the
lifetime gift tax exemption reduces dollar for dollar the amount of the estate tax exemption available at the donor's death.  The lifetime exemption applies to taxable gifts that are in excess of the federal annual gift tax exclusion amount, which is currently $12,000 per donee per year, increasing to $13,000 in 2009.

Unfortunately, very little information has been publicized regarding the positions of Senators Obama and McCain on the federal gift tax.

Proposed Legislation
This past July, Representative McDermott introduced a bill in the House, then Senator Carper and co-sponsors introduced a bill in the Senate two days later related to estate and gift tax reform.  If passed, both bills will permanently reform the current estate tax regime by, among other things, repealing the current legislation that eliminates the estate tax in 2010 for one year.  Although changes are unlikely to occur this year, we have outlined the proposed reforms, which contain different terms:

The Senate Bill - $3.5 Million Exemption
This bill would permanently fix the lifetime estate tax exemption at $3.5 million, adjusted for inflation.  It would also keep the estate tax marginal rate at 45%.  The gift tax exclusion would be $1 million, and the gift tax rate would be capped at 35%.  The bill also addresses rules to be used when determining the impact that taxable gifts have on a decedent's estate tax credit.  For example, current law provides that the applicable gift tax rate should be determined as of the date the gift is given, the new bill proposes that the gift tax rate would be determined as of the date of the deceased giver's death.  This bill is particularly noteworthy because it is one of the only times that Senators from both parties have co-sponsored estate tax reform legislation in a bipartisan effort.
 
The House Bill - $2 Million Exemption
This bill would set the lifetime exemption at $2 million, adjusted for inflation, rather than $3.5 million.  Unlike the Senate bill, which retains the current separation of the estate and gift tax, the House bill would reunify the gift and estate taxes.  Therefore, instead of the applicable lifetime exclusion amount for the gift tax being $1 million, it would equal $2 million in the year 2009, also indexed for inflation.

A surviving spouse's exclusion amount would be increased by any unused exclusion from a deceased spouse, if the executor makes an appropriate and timely election upon the deceased spouse's death.  If the surviving spouse had been married more than once, the exclusion amount could also be reduced by the unused amount of more than one deceased spouse; however, the total for each deceased spouse would be capped at the $2 million base and adjusted for inflation.

For all estates between $1.5 and $5 million, the estate tax rate would be 45%.  However, for estates between $5 and $10 million, the estate tax rate would be 50%.  The estate tax rate would be 55% for estates worth over $10 million.  Finally, the House bill would reinstate the State death tax credit while repealing the deduction for such taxes, reversing prior 2001 legislation.
  
Current Status
While the Senate Finance Committee held a hearing on these proposals earlier this year, the House Ways and Means Committee has not done so.  It is unlikely that the House bill will pass before the presidential elections in November.  Nevertheless, the very fact that the bills exist is expected to catalyze Congressional action in this area.

If you have any questions about this article or would like more information about the proposed bills, please do not hesitate to contact a member of our Taxation & Estate Preservation Group.