Estate Tax A Key Hang-Up In ‘Fiscal Cliff’ Talks

Changes to the federal estate tax may be on the way as the White House and Republicans on Capitol Hill negotiate a solution to the looming "fiscal cliff" facing the country.

The two sides have four weeks to reach an agreement on how to cut the federal deficit before going over the so-called fiscal cliff, a scenario that grew out of last year's partisan impasse over whether to increase the nation's borrowing authority. Congressional Republicans agreed to raise the debt ceiling in exchange for the promise of future budget cuts. To keep the pressure on Congress to reach a deal, lawmakers passed legislation that would automatically trigger across-the-board cuts to both defense and entitlement programs on Jan. 1 — the same time that a series of sizeable tax cuts passed under former President George W. Bush are set to expire.

The estate tax, one of those set to expire, has become a point of contention between Democrats and Republicans in the fiscal cliff negotiations.

Democrats, led by Obama, are pressuring Republicans to approve a deal that extends most of the tax breaks passed under former President George W. Bush, while allowing those affecting the wealthiest 2% of Americans to expire. Republicans have pushed back against increased tax rates, arguing that limiting tax deductions, closing loopholes in the tax code and cutting entitlements like Medicare and Medicaid can significantly lower the deficit.

Currently, inherited assets that exceed $5 million are taxed at 35%. President Barack Obama has proposed raising that rate to 45% after a $3.5 million exemption as part of his plan to address the fiscal cliff. Obama's proposal would increase taxes by $1.6 trillion over 10 years, cut Medicare and other entitlement programs by $400 billion and also includes $50 billion in stimulus spending.

Earlier this week, House Speaker John Boehner rejected the president's proposal, saying it was "not serious." Boehner countered with a plan that would cut the deficit by $2.2 trillion deficit-cutting. Boehner's proposal includes $800 billion in additional revenue over the next decade from an overhaul of the tax code and limiting deductions. Boehner's plan does not specifically mention the estate tax.

Both the Obama and Boehner plans have met with bipartisan criticism on the Hill. But some insurance industry trade organizations are offering their support for raising the estate tax.

The life insurance industry in particular supports increasing the estate tax and lowering the exemption.

A higher estate tax rate makes it more likely that estate planners will turn to life insurance to help alleviate the additional financial burden. That said, it puts those in the industry in an odd position when dealing with consumers. As Parks Lee, an investment adviser representative at Parks Lee Financial Services MetLife in Alabama, told Best's News Service in October, the industry wants to favor the taxpayer, but life insurers would be "delighted" by the opportunity for more life insurance sales (Best's News Service, Oct. 19, 2012).

Jamie Pressly, an estate-planning attorney in West Palm Beach, Fla., said added that if Congress and the White House fail to reach a fiscal cliff deal, life insurance, already an important estate-planning tool, will become even more important because taxes on estates would be much higher, and more people would be included (Best's News Service, Oct. 19, 2012).

Chris Morton, vice president of legislative affairs at the Association for Advanced Life Underwriting, said his organization supports raising the rate to 45% after a $3.5 million exemption, saying that AALU's members "have been strongly in favor of getting a permanent and sustainable solution to the estate tax."

Morton said that the certainty engendered by a permanent estate tax would help life insurance professionals plan for policies written decades before death benefits are issued.

However, Morton noted that the difference between the current rate of 35% after a $5 million exemption and the Obama proposal is about $100 billion over the next 10 years. "There is certainly a cost element that should be considered as part of the issues being discussed in the fiscal cliff."

Morton also said AALU supports a continuation of unified estate and federal gift tax credits. "We support unified tax credits because it allows clients to transfer assets during life and not just death, which helps in business succession," Morton said. "If we can get past the question of how top earners should be taxed, we could get to questions like the unified credits."

As the fiscal cliff negotiations proceed, Morton said the life insurance community will be watching to see whether any of the proposed changes would affect how the tax code views life products. "The current system is appropriate and shouldn't be changed.," Morton said.

At this stage, however, Morton said he doesn't expect a long-term deal to overhaul the tax code in the near future. "We could see them come up with something for the short term and then come back later," he said. "

(By Jeff Jeffrey, Washington Bureau Manager: jeff.jeffrey@ambest.com)