An Update on Changes to the Federal Estate Taxes

Recently, there was a report that President Barack Obama and Democratic lawmakers planned to freeze the estate tax at the current level of $3.5 million exemption per estate, which would prevent the temporary one year repeal of federal estate taxes in 2010, with the tax returning in the following year with only a $1.0 million exemption, along with a tax rate of as much as 55%.

The U.S. Chamber of Commerce recently urged President Obama to repeal the tax for good.  The Chamber apparently senses that the tax threatens a small business whose proprietor dies, leaving a number of debts behind, including the Federal Estate Tax burden, that could force the proprietor’s family to liquidate the family business.

Towards the end of January, Rep. Earl Pomeroy introduced HR 436, which would cap the federal estate tax exemption at $3.5 million and set the tax rate for estates that exceed that amount at 45% (50% for estates between $10 million and $23.5 million).  This part of the bill is amenable to most people, assuming that Congress will not completely repeal the Federal Estate Tax, as the U.S. Chamber urges.

The problem with the bill is that the law would be changed to not allow an appraiser to take any discounts for a minority interest or lack of marketability in an entity that is not actively traded.  For instance, if you own a 10% interest in a partnership, your estate would report that you owned that 10% and value it at 1/10th of the total fair market value of the underlying assets, even though you do not have any control of the partnership and do not have the ability to sell your interest.  If you did have the ability to sell your interest, the potential buyer would probably offer you less than 1/10th of the fair market value of the underlying assets, since you do not have control and there is a limited market.

This means that your estate will show the full 1/10th of the full fair market value of the underlying assets, even though if such asset were sold, your estate would be paid less for it.

While the use of discounts has been a subject of abuse in certain cases, it is obvious that discounts should be allowed to mirror economic reality in following what a willing buyer would pay a willing seller where there is a limited market for the interest and no control.  Hopefully, this portion of the bill will be changed before it becomes the law of the land.