Where will the needle land on the estate tax?

There is plenty of uncertainty surrounding the estate tax.

In fact, the only sure thing is that Congress will punt the issue to next month — or perhaps beyond the fall elections.

Nevertheless, a rough picture of what will happen is starting to emerge.

Last month, Sens. Jon Kyl, R-Ariz., and Blanche Lincoln, D-Ark., offered a proposal to set the estate tax rate at 35% permanently and eventually allow a $5 million exemption. The House passed a bill late last year that would permanently set the estate tax rate at 45%, with a $3.5 million exemption

Mr. Kyl and Ms. Lincoln had hoped to attach their provision to a small-business-lending bill. That effort has stalled for now because it fell short of the 60-vote threshold required to beat back a filibuster.

Still, the Kyl-Lincoln proposal is far from dead. Its terms, and those in the House bill — have established the parameters for a revamped estate tax.

“That seems to be the full extent of the conversation these days,” said Tom Abendroth, a partner at the law firm Schiff Hardin LLP.

Any compromise between the two ends of the spectrum would probably revolve around the number of years over which the new policy is phased in or whether different rates would apply to estates of different sizes, he said.

The estate tax lapsed this year. If Congress fails to act by Dec. 31, the rate will revert to 55%, with a $1 million exemption.

Observers on Capitol Hill tend to agree that legislators won’t let that happen. Still, the limbo surrounding the estate tax is of particular concern to investment advisers and their clients, who are hamstrung if they are beneficiaries or are considering changes to their own wills.

Beyond the estate tax, the question of renewing the Bush-era tax cuts is creating deep political fissures.

Several measures that are important to advisers and investors are set to expire at the end of the year if Congress doesn’t act. Those include reductions in the marginal tax rate, as well as those on capital gains and dividends.

“This uncertainty is going to continue until the end of September. It might continue until December,” said Clint Stretch, managing principal of tax policy at Deloitte Tax LLP.

If the Bush-era cuts expire, the capital gains rate will increase to 20%, while dividends could be taxed at 39.6%. The same individual rate would be imposed on the wealthiest taxpayers.

The Alliance for Savings and Investment, which represents companies and trade associations, is fighting to maintain the 15% tax rate for capital gains and dividends.

“Keeping the dividends and capital gains rate tied together is extremely important,” said Jim McCrery, a partner at Capitol Counsel LLC and a spokesman for the alliance. Without the parity, “you’re going to tip the scales in the minds of many investors toward stocks that appreciate in value rather than stocks that have a high dividend but less capacity for longer-term share value appreciation.”

With higher rates on dividends, companies might decide not to distribute them.

“You reduce the income of seniors who are depending on those dividends for their livelihood,” Mr. McCrery said.

It is still unclear what will happen with the capital gains and dividend tax rates. But the estate tax could play a pivotal role in resolving the tax tangle, according to Mr. McCrery, a former Republican congressman from Louisiana and a member of the House Ways and Means Committee.

He thinks that the estate tax is the linchpin in resolving the rest of the tax policy squabbles. If Congress can get an agreement on the estate tax, Mr. McCrery said, that will clear a path to addressing all the other Bush administration tax cuts.

“My best guess is, given the fragile nature of the economic recovery, Congress is going to choose to kick this can down the road and extend all [Bush administration] tax cuts for at least another year,” he said.

Mr. Stretch foresees congressional action on the estate tax, if for no other reason than constituent pressure. In California, Connecticut and New York — home to six Democratic senators — many estates have zoomed past the $1 million threshold because of the huge appreciation in housing prices over the past 40 years, he noted.

Returning to the $1 million exemption “would be a bad thing for many important Democrats,” Mr. Stretch said.

Such a move not only would be unpopular with the wealthy but with voters of modest means as well.

“The $1 million exemption restores the estate tax to being a tax on the middle class,” Mr. Abendroth said.

No matter what rate and exemption Congress sets for the estate tax, the question of what to do with 2010 estates still looms large.

Lawmakers could approve a retroactive tax. Beneficiaries might be given a choice to keep the zero rate, with other adjustments, or to pay the new rate.

Either option is bound to infuriate heirs of testators who die this year.

“Whatever Congress does in this area, people are going to sue somebody,” Mr. Stretch said. “I wouldn’t want to be an executor.”

E-mail Mark Schoeff Jr. at [email protected].