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Failed Estate Tax Leaves Opportunity to Fix Carry-Over Basis

Where Congress goes from the Senate's failed full repeal vote.

The U.S. Senate failed to secure the 60 votes necessary to proceed to debate on permanent estate tax repeal, leaving several senators looking for a compromise that does not dig deeper into the growing deficit but also meets the needs of farmers.

IowaStateUniversity tax specialist Roger McEowen wasn't surprised by Thursday's 57-41 vote. He's not giving up hope on legislation that more effectively addresses the needs of U.S. farmers though.

Currently law sets the exemption amount at $2 million with a 45% maximum rate (46% in 2006) from 2006 to 2008. In 2009 the exempt amount jumps to $3.5 million. In 2010 the estate tax is fully repealed and the max rate is 0%. Unless the tax act is reenacted before the end of 2010, the estate tax repeal sunsets in 2011.

In previous votes, over 60 senators at one time or another supported full repeal. Last fall it looked like supporters of the repeal would find victory until the Senate pushed back the vote after Hurricane Katrina and Rita hit, which brought new light to rising deficit numbers.

The price tag of full repeal was the reason behind two Republicans siding with Democrats on the vote. McEowen explains compromise legislation can maintain 60% of current revenue generated from estate taxes while taxing only the wealthiest estates. The latest Internal Revenue Service data indicates you can set exemptions at $3-4 million, indexed for inflation, and very few estates would have to pay. In 2004, only 30,000 estates of the 2.4 million deaths paid estate taxes. Only 3,400 of those 30,000 were more than the $3-4 million level.

Sen. Jon Kyl, R-Az., proposed an exemption level of $5 million and a 15% flat rate. Sen. Chuck Grassley discussed raising the flat rate to 25% for estates over $25 million. McEowen doesn't see senators agreeing to Kyl's proposal because it only cut costs of a full repeal by 17%.

Chances of repeal

Senators are already attempting to salvage momentum on Thursday's vote to gain the remaining votes needed for a successful compromise.

McEowen says it is a political year for the House and it may be willing to take up a scaled-down version of estate tax repeal. In the end, McEowen says the best answer - and most-likely option - for farmers is an exemption level of $4 million. "I don't think the rate will go down as low as 15% but it may be near the gift tax rate of 35%," he says.

"In the end, Congress has to decide where to draw the line," he says.

No vote saves step-up basis

For more than 98% of U.S. citizens, income basis is actually more important to them economically than either federal estate tax or generational skipping transfer tax. McEowen says the key question is whether agriculture is better served with a repeal of the federal estate tax with a modified carry-over basis rule, or retaining the tax with higher exemptions and maintaining new basis at death.

If the House's bill was approved, the issue of basis wasn't addressed, McEowen explains.

Under current law gains on assets held at death by a decedent are eliminated. Technically, the "income tax basis" on such assets is adjusted at death to the fair market value of the assets (or the value used for figuring federal estate tax if different from fair market value). That adjustment is commonly referred to as a "step up" in basis inasmuch as fair market value of assets is often higher than the income tax basis of the assets before death.

"If land is held for a long period of time any appreciation of that value is passed on to heirs at current fair market value but without capital gains to pay," he states. It's pretty easy in the Midwest and coastal regions with pressure from commercial development to see lands appreciate at high values, even near the $2.3 million levels. However, exemption levels at $3.5 million would take care of this, McEowen explains.

To read more about estate tax from McEowen's perspective, check out his Web site at: and

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