By Richard Rubin, Bloomberg News (TNS)

WASHINGTON — Congressional Republicans have narrowed the estate tax so much that it affects only about 5,500 wealthy American households a year. Now they want to eliminate the tax altogether — with a bonus for heirs.

Under the latest plan, backed by farmers and business groups, estates would pay no taxes. Furthermore, heirs wouldn’t owe any capital gains taxes on the increased value of assets over the deceased’s life.

That move — simpler and more generous than previous repeal efforts — would let billions of dollars in income and assets escape all U.S. taxes. The plan would cost the U.S. government $269 billion in lost revenue over a decade.

The House of Representatives will vote this week on the latest effort to repeal the tax, which is now paid by only 0.2 percent of U.S. estates. Republicans are drawing attention to what they see as an unjust levy by bringing up the legislation at the annual tax-filing deadline.

They’re also shrugging aside criticism from President Barack Obama, who calls the plan a budget-busting handout to the nation’s wealthiest families at a time when lawmakers should focus on the middle class. Instead, they’re moving in the opposite direction, making repeal more attractive for business owners and creating an even wider gap between the parties on how to tax inherited wealth.

The new Republican plan is different from past repeal bills in a technical yet important way. If it became law, families would be able to pass assets across generations and avoid capital gains taxes on both real gains and so-called phantom income attributed to inflation.

“When you look at the bill, it actually doesn’t make sense; it would get a bad grade in a law school final exam,” said Ed McCaffery, a law professor at the University of Southern California who favors repealing the estate tax. “That is telling old people, clutch onto things until they die. That’s not how the American economy works.”

The first full House vote on estate tax repeal in ten years would reaffirm Republicans’ position to kill what they have long labeled the “death tax.”

It would also let the more than 60 percent of House members who were elected since the last repeal vote take a formal position on the issue.

Repeal won’t happen anytime soon, not with Obama proposing higher estate taxes and only one Senate Democrat siding with the chamber’s Republicans during a test vote on the issue last month. Instead, the House measure is a marker for the 2016 campaign and a signal from Republicans to business groups that repealing the estate tax is a priority.

“The death tax is the wrong tax at the wrong time, and it hurts the wrong people,” said Representative Kevin Brady (R-TX), lead sponsor of the House bill.

He said business owners already pay hefty taxes during their lifetimes and said some families’ holdings have been subject to the estate tax multiple times.

“They are double and triple taxed,” he said.

Republicans and business groups point to the difficulties faced by family businesses, including the expenses of tax planning to minimize or avoid the tax.

“We are often asset-rich but cash-poor,” said Andy Harig, director of government relations for the Food Marketing Institute, which will bring 200 grocers from across the country to Washington this week. “A lot of our members are sometimes surprised when they do the valuation to find out what their businesses are worth.”

Obama and other Democrats say estate tax repeal — especially now with a $5.43 million per-person exemption — is actually about protecting the very wealthy.

“One of the laws that my friends on the other side of the aisle are trying to pass right now is a new, deficit-busting tax cut for a fraction of the top one-tenth of one percent,” the president said on April second in Louisville, Kentucky. “That’s fewer than 50 people here in Kentucky who would, on average, get a couple million dollars in tax breaks.”

The new twist this year is the way that Republicans have structured the legislation, breaking with their approach in bills from 2000, 2001, and 2005.

Back then, they paired estate tax repeal with what’s known as modified carry-over basis. Under that system, heirs who choose to sell inherited assets pay capital gains taxes on the full gain since the asset was purchased, minus an exemption to protect families outside the very top of the wealth scale.

In what became the law for 2010 only, heirs could reduce that tax with a capital gains exemption of up to $1.3 million, with an extra allowance for surviving spouses. That approach ensured death wasn’t a taxable event and allowed heirs to defer taxes until they chose to sell.

This year’s bill is different. It retains what’s known as the step up in basis, which lets heirs defer taxes until they sell and avoid taxes entirely on any increases in value that occurred before they inherited the assets.

That bypasses the complexities and legal fights around carryover basis. It can also be a potent combination, extending rules that now apply for people with less than $5.43 million to the entire population.

Consider a married couple who starts a business with one million dollars and both die in 2015 when the business is worth $50 million. They leave the business to their daughter, who sells it for $60 million in 2017.

Under current law, the couple would have a $10.86 million exemption from the estate tax and pay a top rate of 40 percent on the rest. The daughter would then pay a 23.8 percent capital gains tax on a ten million dollar gain, for a total tax bill of about $18 million.
Under previous Republican plans, the couple would have paid no estate taxes. The daughter, however, would have to pay capital gains taxes on the entire $59 million gain minus the exemptions, for a total tax bill of about $13 million.

Now the parties are moving further apart, because of the Republican approach and Obama’s proposal earlier this year to impose capital gains taxes on appreciated assets at death.

Under the latest Republican plan, the family would pay taxes only on capital gains that occur after the couple’s death — for a total bill of $2.38 million. Obama would charge them about $30 million.

The basis rules are especially important for farmers, who often have assets tied up in land that has appreciated in value, said Pat Wolff, a tax specialist at the American Farm Bureau Federation. Farmers sometimes choose to sell parts of their land, and the basis rules in the Republican measure make that easier and less expensive.

“We asked that the death tax repeal be a straight up repeal bill and not create new taxes for farmers and ranchers,” she said.

Lawmakers should rethink the bill, said Patricia Soldano, a California estate planner who has spent 20 years backing repeal.

“You very possibly would have assets in which the appreciation on those assets is untaxed,” she said. “And I don’t really think people are suggesting that.”

The combination of estate tax repeal and the stepped-up basis rules would be “pretty close” to ending the capital gains tax altogether, said Lawrence Zelenak, a Duke University tax law professor.

“Anybody who can afford not to would never sell an asset during life again,” he said. “It’s just this massive tax favoritism for transfers at death.”

Photo: Judith E. Bell via Flickr