Planning With No Estate Tax

Yes, there currently is no Federal Estate Tax but that means there also is currently no step-up in basis for property with unrealized capital gains. This could cause some heirs to pay more tax than if the Estate Tax was still in force in 2010.

Selling low-basis shares after death is good advice most years, but perhaps not in 2010.

At the moment there’s no Federal Estate Tax but that might change since the Obama 2011 budget proposal currently presumes the Estate Tax will be reinstated retroactively to January 1, 2010, at 2009 rates ($3.5 million exemption).

The elimination of the Federal Estate Tax was coupled with the elimination of the ability for heirs to “step-up in basis” inherited capital gain property. These unrealized gains will not be taxed at death, but instead the inheritors will carryover/assume the original owner’s basis. Only when the heirs sell the property would capital gains be triggered. This could cause enormous nightmares as heirs try to reconstruct and document the basis of inherited property. There is some comfort that in 2010 there is allowed a $1.3 million step-up of unrealized appreciation to heirs and an additional $3 million if the inheritor is the spouse.

Who can be disadvantaged? Although wealth has always transferred from spouse to spouse without Estate Tax the same will not be true for capital gains property with high amounts of unrealized gain inherited in 2010. Children receiving property with gains exceeding the allowance will face a new calculus on what to do with inherited shares. Inherited real estate with negative basis and limited value would create gains tax where there would have been little Estate Tax to pay in 2009 or 2011.

Most wills would need to be edited to reflect the temporary elimination of the Federal Estate Tax or risk the possibility that monies will not be distributed as intended.

Most wills concerning sizable estates are set to distribute property among the heirs with reference to amounts allowed under Estate laws or Generation Skipping Tax provisions that (for now) don’t exist. As an example, to maximize wealth transfer under the old rules, many wills are directed to first distribute the maximum amounts allowed to be left to the next generation without Estate Tax. After that, everything else goes to the spouse Estate Tax free. Utilizing that methodology in 2010 could cause all the wealth to go to the next generation with nothing for the spouse, certainly not what was intended.

The Congressional Budget Office (CBO) forecasts that wealth transfer gifts will skyrocket in 2010 to take advantage of the tax scenario.

Besides dying in 2010 is there any way to take advantage of this unique year? First, considering the old law may be put back in place retroactively, don’t do anything you wouldn’t have done eventually or make sure whatever you do is reversible. A December report from the CBO predicts that gifts will rise from $3 billion last year to $42 billion this year. Here’s why, there is still a Gift Tax, it is 35%. That’s down from 45% last year and a lot less than the 55% that is supposed to kick in next year. Along with the disappearance of the Estate Tax also went the Generation Skipping Tax. Monies gifted to grandchildren (or descendants even further down the line) in 2011 are scheduled to be taxed at a tad under 80%. Currently, 2010’s 35% Gift Tax looks like a bargain. The table below shows the CBO actual/projected receipts generated by the Gift Tax. The CBO observes an earlier spike in gifts “when the Tax Reform Act of 1976 raised the maximum Gift Tax rate from 57.75% to 70%. Gift Tax receipts quadrupled in the months between the law’s enactment and its effective date”.

Gift Tax Receipts, Fiscal Years 1945 to 2019 (Billions of Dollars)

Source: Congressional Budget Office December 18, 2009

There are a few gifting possibilities that have been suggested that can be “undone” if the laws change retroactively. I hear that if there is a “fix” it will be retroactive but the law would also give taxpayers passing away between January 1st and enactment a choice to file as if there was no Estate Tax (eliminating constitutional challenges). Finding a political middle ground has proven difficult so far, and there’s no reason to believe it will get much easier this being a contentious election year. It might be worth considering the possibility that we won’t have an Estate Tax in 2010.