Reuters Money

Lance Hall is the co-founder & President of FMV Opinions. The opinions expressed here are his own.

On Monday, President Obama announced that he had reached an agreement, in principle, with the Republicans on the extension of the Bush tax cuts.  One of the items negotiated was the estate tax.  In this case, the Republicans got what they wanted: a 35 percent estate tax and a $5 million exemption.

Unresolved, however, were certain critical details such as:

* Will the estate tax be retroactive to January 1, 2010 or will it begin January 1, 2011?

* Will the lifetime gift tax exclusion amount be reunified with the estate tax exemption amount as it was prior to the 2001 Economic Growth and Tax Relief Reconciliation Act?

* Will the surviving spouse be allowed to use the unused portion of the descendant’s lifetime gift tax exclusion amount?

* Will the lifetime gift tax exclusion and estate tax exemption amounts be adjusted for inflation?

Here is a deeper look at each of these issues:

Retroactivity

Retroactivity can be a positive or a negative, depending on the size of the estate. If, in the final negotiations, the estate tax becomes retroactive to January 1, 2010, large estates, such as George Steinbrenner’s, will obviously have a significant estate tax payment due.

However, many smaller estates will benefit. Under the old estate tax rules, at death, there was an automatic step up in basis to the date of death value which provided all estates with a tax shelter from capital gains taxes.  With no estate tax in 2010, estates no longer get a full step up in basis.  With a $5 million exemption amount, a $4 million estate will pay no estate tax and get a step-up in basis.

Interestingly, while many Republicans would not favor a retroactive estate tax, in the weeks preceding the Bush tax cut settlement, Senate Minority Leader, Mitch McConnell, and Ranking Minority Member of the Senate Finance Committee, Charles Grassley, sponsored legislation that taxed estates at 35 percent, had an exemption amount of $5 million, allowed for spousal portability and the exemption amount was inflation adjusted but, surprisingly, was retroactive to January 1, 2010.

Reunification

Prior to the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001, the lifetime gift tax exclusion amount and the estate tax exemption amount were the same.  This meant that instead of waiting until one’s death to exempt a portion of the estate, an individual could gift — tax-free — an amount equal to the estate tax exemption amount during their lifetime.

However, after 2001, the lifetime gift tax exclusion amount  remained at $1 million while the estate tax exemption gradually increased to $3.5 million in 2009.  With a new estate tax exemption amount of $5 million, large estates will benefit from a reunification of the lifetime gift tax exclusion and estate tax exemption.

Spousal portability

It is natural for individuals to ignore their mortality until death’s door.  As a result, many individuals fail to use there lifetime gift tax exclusion amounts.  There is considerable support for allowing the surviving spouse to use any unused portion of the lifetime gift tax exclusion amount.

Inflation adjusted

Inflation can increase the nominal value of an estate without increasing an estate’s purchasing power.  Over time, a fixed estate tax exemption amount will trap an increasing number of estates merely because inflation has increased the value of the estates despite the purchasing power of the same estate remaining constant.  Accordingly, many politicians favor adjusting the exemption amount for inflation.

Retroactivity, reunification, spousal portability and inflation adjusting are critical details that are currently being negotiated.  For political junkies, if the Republicans get their way on all of these provisions, this will be more evidence that President Obama surrendered to the Republican minority.