At the Finance Committee markup last week on the Agriculture bill, Senator Jon Kyl (R-AZ) offered an amendment to make permanent changes to the estate tax.

The Kyl amendment would have created a new framework for future estate tax levies with a $5 million unified exemption (per spouse) and a two-tiered rate system: capital gains rates for estates up to $25 million and 30 percent rates for estates above $25 million.

In exchange for Senator Kyl withdrawing his amendment, Finance Committee Chairman Senator Max Baucus (D-MT) promised to hold hearings on the estate tax later this year followed by a markup of legislation to take place sometime next spring.

This promise from the Chairman appears to have been inevitable once the House added tax provisions to its version of the Agriculture bill – in effect turning the bill into a revenue measure eligible for additional tax provisions. Death tax coalitions have always relied on the imagery of farms and small businesses to press their case, and a farm bill with estate tax reform attached is an attractive marriage of messaging and policy.

The big question now is whether the major business groups – NFIB and the Farm Bureau to start – will actively support a potential compromise on the estate tax or hold out for full repeal. Remember, the death tax goes away completely in 2010 followed by the return of the full death tax (55 percent top rate, $1 million exemption) in 2011, so the clock is ticking for something permanent to be done.

House Defeats Permanent Death Tax Repeal

Speaking of full repeal, the House voted on full repeal of the estate tax yesterday during the floor debate over the IRS’s use of private debt collectors. The motion failed on a mostly party-line vote of 196-212. Ten Democrats joined 186 Republicans in favor of the motion.

Even if all the Republicans in the House were present and voting, the total support for repeal would have tallied just 210 votes; eight short of a majority and significantly lower than in previous years.

These simultaneous and disparate approaches on the estate tax in the House and Senate illustrate the on-going tension between estate tax opponents who are holding out for full repeal and those who advocate cutting the best deal possible given the new leadership and current political trends. The estate tax repeal effort was successful because it focused on the fundamental unfairness of the underlying tax. Given the erosion of votes in support of repeal, however, the chorus of estate tax opponents who support some sort of compromise is growing.

S Corporation Valuation Issue

Pop Quiz: Did you know that the IRS discriminates against S Corporations when it comes to estate taxes and other matters where business valuation plays a role?

Under the current IRS approach, S corporations are subject to a 60 percent or higher premium over similar C corporations when they are being valued as part of an estate. This discrimination stems from the Gross v. Commissioner case back in 1999. The effect of that decision is that, in many cases, the IRS fails to adjust the fair market value of an S corporation to reflect the business’s overall tax liability, as they do when assessing the fair market value of a C corporation.

S-Corp advisors Nancy Fannon and Chris Treharne have written extensively on the subject, including this submission to the Department of Treasury on behalf of the S Corporation Association. More recently, Chris has put together a presentation and Nancy has written a book on the subject, The Comprehensive Guide to S Corporation Valuation, both of which do a great job of laying out the entire issue.

If there is an estate tax compromise in the cards, Congress should be aware of this on-going discrimination on the part of the IRS against S corporations. S corporations do pay taxes – through their owners – and this tax burden should be reflected in their fair market value when they are part of an estate.