Is 2010 a Good Year to Die?

For the first time since 1916, there is no federal estate tax. As a result of tax cuts enacted under President George W. Bush, the federal estate tax disappeared on January 1 of this year. So what’s next?

In 2001 you could leave tax-free $1 million to a person other than a spouse or a charity (the estate tax exclusion amount); anything over that amount was taxed at a maximum rate of 55%. That amount has been raised incrementally over the past nine years to a high of $3.5 million per individual. The tax rate was lowered to 45% on assets over that amount.

Unless Congress acts this year, the estate tax will revert to the pre-Bush rules on January 1, 2011, with a $1 million exclusion amount and a 55% top tax rate. For people trying to plan and allocate their assets wisely, this uncertainty can be frustrating and potentially very expensive.

Many estate planning documents written in the last 20 years contain formulas and concepts that no longer exist under current law. It is vital to touch base with your estate attorney to make sure your current plan still is effective and accurate and revise it if it is not.

And, if things go unchanged, the little guy will be hit harder because the repeal of the estate tax in 2010 is effectively replaced by a 15% capital gains tax.

Imagine that your spinster Aunt Sophie leaves you stock valued at $400,000 that she paid $20,000 for over twenty years ago. If she died last year, no estate tax would be owed under the exclusion amount. You would receive a “step-up” in basis to the fair market value at her death and could sell the stock at $400,000 without incurring any capital gains.

If she died this year, however, no estate tax would be due but her basis of $20,000 would “carry-over” and you could pay capital gains tax on the $380,000 difference if you sold the stock at its current value unless her executor allocated some of her basis increase of $1.3 million allowed under the new law to the stock.

And that assumes you knew what Aunt Sophie paid for the stock. Having experienced first-hand the difficulty of reconstructing the basis of assets acquired by decedents many years before death, I can verify that it’s going to be a nightmare.

With banks and institutions disappearing through merger at an alarming rate, the chance of finding documents concerning basis is less likely now than it was the last time we had carry-over basis in the 1970s.

Speculation is rampant about what happens next but there are three likely scenarios. First, Congress could pass federal estate tax legislation later this year, and people who die between January 1, 2010, and the date of the new legislation don’t pay any estate tax.

Another possibility is that legislation passed later this year would be retroactive to January 1.  Some taxpayers may take the government to court on constitutional grounds but they will be up against a U.S. Supreme Court that has upheld the constitutionality of retroactive tax hikes since the mid 1870s.

A third option is that nothing is done this year and the law reverts to 2001 rules. That would create an estate tax problem for many people including grandma who may want to consider hiring a taste tester for Thanksgiving.

So what will happen? My guess is there will be no federal estate tax for deaths in 2010 creating a huge accounting mess. This guess is based on:

1. The inability of our dysfunctional Congress to address estate tax reform;
2. More pressing issues facing our legislators;
3. Contested seats in the mid-term elections; and
4. No one has the stomach for a dogfight over a retroactive tax since a couple of multi-billionaires have already died this year.

My bet is later this year Congress will change the estate tax exemption for years 2011 and beyond in line with the 2009 exclusion amount of $3.5 million with a 45% top tax rate.

What do you think?

About the author

Michael Roberts wrote 3 articles on this blog.

Michael Roberts is an accomplished wealth management executive and attorney who brings to clients a strategic understanding of how trusts can be used to preserve and transfer wealth through taxefficient and effective intergenerational planning. He has over 20 years experience in the financial services industry, most recently as President of UBS Trust Company, N.A. Prior to that he was a Regional Managing Director of Personal Trust for Wachovia, responsible for more than 20 trust offices with assets of $11 billion.

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