| On
June 7, 2001, President George W. Bush fulfilled his campaign promise
to reduce taxes by signing a much ballyhooed $1.35 trillion tax cut
package known as the Economic Growth and Tax Relief Reconciliation Act
of 2001. The good news is that the new law amounts to the largest tax
cut in more than 20 years. The bad news is that some of the changes may
expire or may not take effect at all. One change that might not take
place has to do with the estate tax. So even though the President might
boast that the new law has killed the so-called death tax, reports of
its death might be premature.
The new tax package does include a repeal of
the estate tax, but it doesn’t kick-in until the year 2010. In the
meantime, the estate tax exemption increases from $675,000 in 2001 to
$1 million in 2002 and 2003, $1.5 million in 2004 and 2005, $2 million
for 2006 through 2008 and $3.5 million in 2009. When the year 2010
rolls around the estate tax is gone. Too bad this isn’t the end of the
story.
If you are “lucky” enough to die in 2010,
then perhaps your heirs will sidestep the estate tax. However, the
repeal is temporary. That is, if you make it to 2011, the entire tax is
scheduled to be back with just a $1 million exemption. You see, in
order to meet budgetary restrictions; the new act contains a so-called
“sunset” provision that brings the current estate tax rules back in
force in 2011. As such, this sunset provision will keep the debate on
the estate tax brewing for the next decade. It will no doubt be a key
issue in the two presidential and four congressional elections between
now and 2010. In the meantime, the taxpaying public will be left
questioning the final outcome as they struggle to plan their affairs.
Once the estate tax is fully repealed in
2010, heirs will be faced with a new rule on assets they inherit. Under
the current law, when you die, your heirs receive your assets with a
“stepped-up” basis equal to the value of the asset on the date of your
death. For example, assume you bought your Google shares at $100 per
share, but they are trading at $500 per a share when you die. Your
heirs get to use the $500 value when they sell the shares, so that the
$400 gain escapes tax. After the estate tax is repealed, this
“stepped-up” basis will apply to $4.3 million in assets passing to a
spouse and to $1.3 million in assets inherited by non-spouses. However,
your heirs will be stuck using your original cost on all assets over
those limits. Just imagine the paperwork nightmare as you try to keep
track of those assets that get a new basis and those that don’t.
Somehow tax simplification got lost in this part of the tax cut.
If things weren’t complicated enough, even
though the estate tax is phased-out, the gift tax is set to stay on the
books. Congress was concerned that without a gift tax, wealthy
taxpayers would make large gifts to family members in lower income tax
brackets. To prevent this, even after the repeal of the estate tax, the
law retains the gift tax with a $1 million exemption.
2010 UPDATE: While most thought that
Congress would revisit the estate tax before the end of 2009, they did
not. As such, effective January 1, 2010, there is no federal estate
tax, and without further action the tax will come back in 2011 with a
$1 million tax exemption. Some advisors believe that Congress will
take action to reinstate the federal estate tax at 2009
levels retroactive to January 1, 2010, but the future of the federal
estate tax is certainly uncertain. Stay tuned.
The important message is that those who made
an estate plan based on
the federal estate tax law as it existed prior to 2010 should have
those plans reviewed immediately as they may not have anticipated this
temporary estate tax repeal and, as such, the plan they have in place
may yield unanticipated results.
Last revised 2/28/2010
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