By KENT HOOVER
khoover@bizjournals.com

When Congress returns in September, it will have four months to do what it failed to do over the past nine years: fix the absurd situation it created for the estate tax.

As part of the 2001 tax cuts, Congress gradually reduced the tax rates and increased the exemption for the estate tax, which is levied on a person's assets when he or she dies. These tax changes, which were limited to 10 years, repealed the estate tax this year only to allow it to come back next year at 2001's high rates and low exemptions.

Everyone knew this scenario made no sense, but Republicans and advocates for family-owned businesses were confident they eventually could win permanent repeal of the estate tax. Those hopes disappeared when Democrats took over Congress in 2007, and efforts to reach a compromise so far have failed.

If Congress doesn't address the issue by the end of the year, estates valued at $1 million or more would be subject to the estate tax. (For couples, the exemption could be doubled to $2 million.) The top estate tax rate would climb to 55 percent. That's up from zero this year and up from 45 percent with a $3.5 million exemption in 2009.

"There's no way that's going to happen," said Clint Stretch, managing principal of tax policy for Deloitte Tax LLP in Washington, D.C.

If it does happen, many more Americans - including families who own businesses - would be hit by the estate tax or at least the costs involved in avoiding or reducing its bite.

Stretch said the estate tax will be resolved when Congress decides what to do about individual income tax rates for high earners.

Reducing the rates and increasing the exemption for the estate tax could be combined with an income tax increase for wealthy Americans and an extension of current tax rates for the middle class. Or, if Congress decides to extend lower rates for high earners another year, it could pass a one-year fix in the estate tax, as well, and deal with the issue again next year.

Democrats have proposed reviving the estate tax at 2009's levels, while Republicans have proposed more favorable terms for estates: a $5 million exemption and a 35 percent tax rate.

The Family Business Estate Tax Coalition, a group of 51 business groups ranging from the American Farm Bureau Federation to the U.S. Chamber of Commerce, endorsed the Republican alternative.

"The higher exemption level and reduced rate will lessen the burden of the estate tax and provide family businesses and farms with more capital to create much-needed jobs and invest in their business," the coalition wrote in a letter to senators.

Lawsuits will be filed challenging whether Congress has the authority to tax an event - death - that already has occurred. One possible compromise would allow this year's heirs to choose between paying an estate tax or paying capital gains taxes on the difference between what the decedent originally paid for the assets and the sales price the heirs receive for the assets.

Making the estate tax optional, however, could create tension between executors and heirs, Stretch said. He doubts this scenario was addressed in any wills.

"The policy answer was for Congress to do its job last year, but it didn't," he said.