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Friday, January 15, 2010

Estate Taxes and Family Businesses: Economic Issues

Jane G. Gravelle
Senior Specialist in Economic Policy

Steven Maguire
Specialist in Public Finance

The 2001 tax revision began a phase out of the estate tax, by increasing exemptions and lowering rates. The estate tax is scheduled to be repealed in 2010 and a provision to tax appreciation on inherited assets (in excess of a limit) will be substituted. The 2001 tax provisions sunset, however, so that absent a change making them permanent the estate tax will revert, in 2011, to prior, pre- 2001 law. Proposals to make the repeal permanent, or to significantly increase the exemptions and lower the rate, are under consideration. 

Discussions of the estate tax have focused particularly on the effects on family businesses, including farms, and the perception that the estate tax unfairly burdens family businesses because much of the estate value is held in illiquid assets (e.g., land, buildings, and equipment). The estate tax may even force the liquidation of family businesses. A special family business deduction, the Qualified Family Owned Business Interest Exemption (QFOBI) was enacted in 1997. Because of higher exemptions and a previous cap on the combined regular and small business exemption, this provision is no longer relevant. If, however, the estate tax repeal sunsets, QFOBI will again be germane. 

On December 3, 2009, the House passed H.R. 4154, the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009. H.R. 4154 makes the 2009 provisions, which allow a $3.5 million exemption and a 45% tax rate, permanent. In the Senate, leaders have indicated that they will consider estate tax legislation in 2010. Proposals considered in the Senate during the 111th Congress have included the extension of the 2009 estate tax provisions to 2010, permanently repealing the tax, and increasing the exemption and/or decreasing the rate. At the same time, some proposals focused on allowing an expanded business exemption. 

Despite this attention to family business, evidence suggests that only a small fraction of estates with small or family business interests have paid the estate tax (about 3.5% for businesses in general, and 5% for farmers, compared to 2% for all estates). Recent estimates suggest that only a tiny fraction of family-owned businesses (less than ½ of 1%) are subject to the estate tax but do not have readily available resources to pay the tax. Thus, while the estate tax may be a burden on those families, the problem is confined to a small group. 

If the estate tax is repealed, QFOBI will allow an exemption for some or all of business assets in about one-third to one-half of estates with more than half of their assets in these businesses, but the value of the exemption will be reduced because the general exemption has increased. If the estate tax repeal is made permanent, liquidity will cease being a problem, although family businesses may be more likely than other estates to be affected by the capital gains provisions. Exposure to the estate tax, if it is reinstated, would be significantly decreased by increases in either the family business or general exemptions. The report also discusses an uncapped exemption and an uncapped exemption targeted at liquidity issues. This report will be updated as legislative events warrant.

Date of Report: January 6, 2010
Number of Pages: 18
Order Number: RL33070
Price: $29.95

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