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When Is a Tax Cut a Tax Increase?

Roger McClure June 19, 2009

When is a tax cut a tax increase? Or a tax increase a tax cut? In the case of estate taxes, it is both a tax cut and a tax increase.

President Obama is proposing that the federal exemption for estate taxes stay at its current 2009 level of $3.5 million for the next several years. An exemption of $3.5 million means that you have to have over $3.5 million in your taxable estate to pay any federal estate taxes. But, under the Bush tax cuts, there will be no estate taxes in 2010 and if you have an estate over $3.5 million in 2010, you pay no federal estate taxes under current law. Thus, with Obama’s continuation of the estate tax in 2010, with an exemption of $3.5 million, there will be a tax increase in 2010 for you if have an estate in 2010 over $3.5 million. So, for you dedicated tax avoiders who will do anything to save taxes, forget going to your reward in 2010.

In this crazy world of taxes, the Bush tax cuts expire starting 2011 and then the federal tax exemption will go back to $1,000,000. Thus, an exemption of $3.5 million will be larger than the $1 million exemption in 2011 and therefore a change to $3.5 in 2011 will be a tax cut. And this is a tax cut for the wealthy between $1 and $3.5 million, or for a couple, for a total of $7 million.

How do we know it is going to be $3.5 million? The Bush tax cuts are still the law. There is no bill ready for the signature of Obama for the $3.5 million. Any bills bouncing around Congress now are unlikely to be the one that puts it at $3.5 million.

But, Obama’s budget figures assume there will be a $3.5 million exemption next year and for several years later. The top lobbyists following this expect the Congress will pass and the President will sign a $3.5 million exemption in the fall. If they do not change the law to the $3.5 million, then with no estate tax in 2010, this will be a tax cut that the Obama budget can not afford, particularly when there are large deficits. If they dropped the exemption to $1 million, this would sweep in large numbers of those who live around the DC beltway and might foment angry mobs of wealthy people in suits, or at least, lots of campaign contributions to their opponent in the next election. A $5 million exemption or higher would let too many of the “rich” not “pay their fair share”. So, $3.5 is not too high and not too low, but just right. Most planners are betting on a $3.5 exemption for the coming years.