Capital Letter
By Ronald D. Aucutt
No. 14
Washington, D.C.
Januray 20, 2009
Grand themes play out on our televisions, while mundane issues still hold our interest.
Dear Readers Who Follow Washington Developments:

Today the new Administration begins. We have witnessed much – the tradition of a peaceful and cooperative transition that so much of the world has not known, the unprecedented statement about America that this particular inauguration represents, the Bush Administration’s unprecedented level of graciousness and assistance to the incoming Administration, President Obama’s unprecedented embrace of ideas and contributions from both parties, and the unprecedented domestic and international challenges that give urgency to the new Administration’s mandate. Most of what we have witnessed today has been celebration, pageantry, and style. Not much substance, no details. No analysis of the estate tax in the inaugural address! But, all in all, there is a lot of expectation in Washington. The President enjoys immense good will. There is not as much enthusiasm about Congress, but many are willing to be patient. The new Administration and Congress will have critics; hardly anything they accomplish will please everyone. But they will accomplish something. By and large, there may be as much reason as there has ever been to expect a considerable amount of accomplishment. We might even find ourselves admitting that Washington has found a way to work. At least for a while.


If that is so, it comes at an appropriate time for those of us who are interested in the estate tax, because, although few of us would have predicted it in the summer of 2001, nothing has been done to stabilize the estate tax transitions that were enacted that year. After years in which I’ve tried to find ways to unnecessarily remind readers of Washington Reports and Capital Letters that 2009 is coming – it’s here.


The front page headline in the January 12 Wall Street Journal was “Obama Plans to Keep Estate Tax: Democrats Want to Freeze Levy at Current Levels Instead of Letting It Expire Next Year.” Clearly, for 2010, freezing 2009 law would be an estate tax increase. But, when contrasted to the return to pre-2002 law that remarkably is still on the books for 2011, freezing 2009 law would be a tax cut. But not self-evidently a tax cut targeted to the “middle class.”  Nevertheless, Capital Letter No. 13 set forth some reasons why making 2009 estate tax law permanent would fit in a Democratic agenda for the 111th Congress. The watching of Washington that many Capital Letters readers are explicitly doing today will continue symbolically until the legislation is enacted.

H.R. 436, a Development That Has Captured Surprising Attention

A development that has received a great deal of attention is the introduction of H.R. 436 on January 9 by Rep. Earl Pomeroy (D-ND). The attention is probably overdone (not surprising in today’s atmosphere of anticipation). Rep. Pomeroy is the tenth most senior Democrat on the Ways and Means Committee. There is no indication that this bill reflects much input or participation, if any, from the Ways and Means Committee staff. It is not even featured on Rep. Pomeroy’s own website. Introduced bills are generally numbered sequentially, and it is telling that there were 436 bills introduced by the fourth day of the new Congress. Not all of them will become flagship legislation.

Not surprisingly, H.R. 436 would freeze 2009 estate tax law – a $3.5 million exemption equivalent and a 45 percent rate. An interesting gloss, which has not been the focus of most of the attention, is a proposed revival, effective January 1, 2010, of the 5 percent surtax as a “phaseout of graduated rates and unified credit.” Fellows will remember this from pre-2002 law, affecting the marginal rate for taxable estates between $10,000,000 and $17,184,000. Because of the increase in the unified credit to match a $3.5 million exemption, the surtax under H.R. 436 would apply to taxable estates from $10 million all the way up to $41.5 million. In other words, the marginal rate between $10 million and $41.5 million would be 50 percent (45 percent plus 5 percent), and the ultimate tax on a taxable estate of $41.5 million, calculated with the current unified credit of $1,455,800, plus the 5 percent surtax on $31.5 million (the excess over $10 million), would be $18,675,000 – exactly 45 percent of $41.5 million.

At least the old 5 percent surtax used to work that way when there was a federal credit and no deduction for state death taxes. Today, it would still work that way in “coupled” states where in effect there is no state death tax. Once again, the repeal of the state death tax credit makes the math more complicated in “decoupled” states that impose their own tax. In those states, the actual numbers will depend on the structure of the state tax, but in general the combined federal and state marginal rates for taxable estates between $10.1 million and $41.5 million will be 56.9 percent in states that conform to the federal deduction for their own state taxes and 58 percent in states that have decoupled even from that federal deduction.

Regardless of the stature or future of H.R. 436 in general, the revival of the surtax idea might gain traction in a revenue-minded and middle-class-focused congressional environment. No idea, no matter how it is packaged, ever fades away completely. If a surtax like this were enacted, it would be one more reason to be careful in providing blanket general powers of appointment in trusts subject to the GST tax, because at least the GST tax is imposed at a flat 45 percent rate.

The Valuation Discount Lightning Rod

But the focus of the attention H.R. 436 has attracted has been its imposition of special rules for entity-based valuation discounts – a subject about which there seems to be as much nervousness in the estate planning community as we have ever witnessed about anything. H.R. 436 would add a new section 2031(d), generally valuing transfers of nontradeable interests in entities holding nonbusiness assets as if the transferor had transferred a proportionate share of the assets themselves. If the entity holds both business and nonbusiness assets, the nonbusiness assets would be valued under this special rule and would not be taken into account in valuing the transferred interest in the entity.  Meanwhile, new section 2031(e) would deny a minority discount (or discount for lack of control) in the case of any nontradeable entity controlled by the transferor and the transferor’s ancestors, spouse, descendants, descendants of a spouse or parent, and spouses of any such descendants. These rules would apply for both gift and estate tax purposes and would be effective on the date of enactment.

Some kind of “crackdown” on entity-based valuation discounts has seemed imminent for a long time, if not by legislation then by regulations under section 2704(b)(4) (which has now been on the Treasury-IRS priority guidance list for six years). Even if new rules are harsh, they could be a welcome improvement over the chaos of the current ad hoc, case-by-case approach.

Nevertheless, legislation like H.R. 436 disappoints, and it is good that it probably does not represent the best effort of congressional staffs. It is little more than a dust-off of the proposal to “eliminate non-business valuation discounts” in the Clinton Administration’s budget proposals for fiscal 1999, 2000, and 2001, which itself was basically a repackaging of a similar proposal in “Tax Reform for Fairness, Simplicity, and Economic Growth” (popularly called “Treasury I”), published by the Treasury Department on November 27, 1984, just weeks after President Reagan’s reelection. Missing is any acknowledgment of the critique of the simplistic approaches in past proposals that commentators, heavily dominated by ACTEC Fellows, have patiently offered for many years. Missing, for example, is any effort to relieve the harshness for holders of restricted investments who have done nothing themselves to create or perpetuate the restrictions. Missing is any suggestion that the treatment of valuation might be coordinated with other vexing issues, such as marital and charitable deductions, income tax deductions, and basis. Missing is what some of the boldest among us have hoped for, which is that new objective rules themselves would be bold and exclusive and would oust the haphazard judicial invocation of improvised rule-substitutes.

While the country celebrates today and expects sweeping action on grand themes, there are a few of us who would celebrate a bit more if a little of the can-do spirit and make-it-work energy trickles down and produces even modest action on mundane issues, such as an approach to valuation discounts that is comprehensive, balanced, and workable.

Ronald D. Aucutt
© 2009 by Ronald D. Aucutt.  All rights reserved