Byrd Rule complicates extending Bush tax cuts

The Insider

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February 20, 2005|By BILL BARNHART

Somewhere down the list of priorities for President Bush's tax reform effort you'll find a tax most of us will never face.

But even for investors who take merely a spectator interest in the tribulations of the rich, the fate of the federal estate tax conveys useful insights.

It's the financial planning equivalent of reading Jane Austen novels. The complexities of life at the top mimic ours, with bigger dollar signs.

The tax cut bill enacted in 2001, in Bush's first year in office, is a microcosm of the mind-bending complexity Bush now wants to unwind.

The law trims the maximum estate tax rate to 45 percent in 2007 from 55 percent; eliminates the tax in 2010 and then restores the rate to 55 percent in 2011.

The amount that may be excluded from the tax climbs in 2009 to $3.5 million per individual from $675,000 in 2001, becomes infinite in 2010 and then falls back to $1 million in 2011.

This hairball of tax-writing reflects the fact that Bush doesn't have 60 votes in the Senate to end a filibuster or overcome the so-called Byrd Rule, named for Sen. Robert C. Byrd, the West Virginia Democrat.

Under the Byrd Rule, budget bills may avoid a filibuster, but tax cuts that aren't paid for through spending cuts or revenue-raisers can't outlive the underlying bill without approval of three-fifths of the senators.

The Byrd Rule is the key to understanding the tax reform debate and its tax-planning consequences, says attorney Ronald Aucutt of McGuireWoods, an estate planning expert.

The rule means that a permanent repeal of the estate tax is unlikely, he says. It also explains why the 15 percent rate on capital gains and dividends, enacted in 2003, is set to expire in 2008.

Wealthy taxpayers juggle various components of the code - ordinary income taxes, the alternative minimum tax, capital gains and dividend taxes, plus the estate tax.

Now they'll be juggling in the dark again, with the outlook for tax law unknown, after six changes since 1997.

You don't have to be super rich. As real estate prices climb, more Americans will face problems such as these:

A spouse may pass wealth to the other spouse at death without estate tax.

The spouse sets up a trust for the kids in the amount of the estate tax exclusion. The two exclusions avoid estate taxes.

But what if the estate tax exclusion grows?

"If you weren't doing estate planning in contemplation of the possibility that the exclusion would increase, you could end up shifting too much wealth to your dependents and putting your spouse at jeopardy," said Michael Lee, a wealth manager at William Blair & Co.

If a wealthy taxpayer decides to sell assets before death, to diversify a portfolio, he or she might recover the 15 percent capital gains tax penalty through investment gains.

But if you sell too much in a year you could fall under the alternative minimum tax, said Beth Rodriguez, a wealth manager at J.P. Morgan Private Bank. If you wait, the 15 percent rate might be increased.

Tax issues should not drive investment or estate-planning decisions. But don't ignore taxes. They color every move you make.

As Rodriguez put it, "Make a decision realizing you are making a decision." Jane Austen could not have said it better.

Bill Barnhart is a columnist for the Chicago Tribune, a Tribune Publishing newspaper. E-mail him at

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