“We need to change our estate planning documents before the end of the year when the Bush tax cuts expire.”  For the past month or two, some couple has come to my office making this statement.  People believe now that President Obama has been re-elected, the federal estate tax exemption equivalent (the “credit”) will be allowed to roll back to $1,000,000.

The fact of the matter is, no one can tell you with absolute certainty what is going to happen with the credit, but here are my thoughts.

The federal estate tax is a tax on the gross value of an estate.  If the gross value of the estate exceeds the credit amount, the estate is subject to federal estate tax.  The gross value of the estate includes all assets that the decedent died owning (his bank accounts, 401(k)s, stocks, bonds, annuities, IRAs) and the death benefit of his life insurance policies.

The federal exemption equivalent is a fixed dollar amount.  Currently, the credit is $5,000,000.  If the gross estate exceeds $5,000,000, the estate is subject to federal estate tax.  If the gross value of the estate does not exceed $5,000,000, then the estate is not subject to federal estate tax.

In 2001, the exemption equivalent was only $675,000.  Between 2001 and 2009, the credit gradually rose and ended at $3,500,000.  In 2010, President Obama and Congress extended the Bush-era tax cuts, but they actually increased the exemption equivalent against federal estate tax from $3,500,000 to $5,000,000.

The extension of the Bush-era tax cuts that occurred in 2010 was temporary, designed to only last two years.  The extension expires at the end of 2012, at which time the so-called “fiscal cliff” will occur.  Part of the fiscal cliff involves the federal estate tax.

The history of the federal estate tax has been one in which the government increases the amount that is exempt from federal estate tax.

By the way, there is a New Jersey estate tax.  The exemption equivalent against the New Jersey estate tax is $675,000.  That has been the New Jersey exemption equivalent since 2001, and there are no plans to increase the exemption equivalent for purposes of the New Jersey estate tax.

So, what do I think will happen with the federal estate tax at the end of this year?  If President Obama and Congress fail to act and the fiscal cliff does occur, the exemption equivalent will plummet to $1,000,000.  For this reason, people are coming to my office asking me what they need to do to avoid the problem a significantly lower exemption equivalent will cause their estate.

Back in 2009, I thought that President Obama and Congress would leave the credit at $3,500,000 and index it for inflation.  Instead, they increased the credit to $5,000,000 and indexed it for inflation.  So, that tells you two things:  1.  I cannot predict the future, and 2. The federal government typically increases the credit, it doesn’t lower it.

Now, I think the federal government will leave the credit at $5,000,000 indexed for inflation.  I would put the chances of the credit going down to $1,000,000 at less than 10%.  I also think the government will incorporate a provision called “portability” into the federal estate tax law.

Portability is complex subject worthy of its own article, but essentially, portability permits the estate of the second-to-die spouse to use the unused portion of the first-to-die spouse.  In short, portability permits a married couple to exempt $10,000,000 from federal estate tax with greater ease than currently exists.

Contrary to many people’s way of thinking, I do not think the world is coming to end in 2012, either literally or figuratively.  I do not think that the taxes on people or on estates are going to shoot through the roof.  While I do believe income taxes are going up (and they probably should), federal estate tax will, effectively, decrease.