Estate Taxes – A Headache for 2010

Did you know that as of January 1, 2010, the estate tax has been repealed?

Bill Gates, the founder of Microsoft, is worth an estimated $7 billion.  Now, we do not wish any ill will on Mr. Gates, but under current law, if he were to die, theoretically his heirs would owe $0 in estate tax.

So how did we get into this mess?  This scenario results from a law enacted in 2001 under President George W. Bush which gradually increased the estate tax exemption from $675,000 in 2001 to $3,500,000 in 2009, eliminating the tax in its entirety in 2010.  At the time the law was passed a majority of lawmakers, estate planning attorneys and accountants figured Congress would pass a bill closing the 2010 loophole, but to everyone’s surprise, the clock struck midnight on December 31st and just like that, the estate tax disappeared.

Now the 2001 bill has a provision that the estate tax comes back to life in 2011.  That, in and of itself, creates a whole new set of problems, but let us examine 2010 first.

Where were we?  In 2009, each individual had an estate tax exemption equal to $3.5 million.  Theoretically, if Rob and Amanda are a married couple with an $8 million estate, and they have done the proper estate planning, their heirs would owe approximately $450,000 in estate taxes.  By making use of their estate tax exemption, they could have sheltered $7 million from estate taxes.

Where are we now?  Rob and Amanda lived to see the start of 2010, but both got hit by the proverbial “bus” while crossing the street.  Under the current law, their heirs will not owe any estate tax.

At first glance, by dying in 2010, it looks as if their heirs have come out on the plus side by about $450,000.  Looks can be deceiving.

A little wrinkle under the current 2010 law is that the step up in basis is limited to $1.3 million for the overall estate, plus $3 million for any assets transferred to a surviving spouse.

Prior to 2010 when an individual died, his assets received a full step up in basis.  Thus, if Rob and Amanda held large amounts of low basis stock and died in 2009, their heirs received a full step up on the assets, paying little if any capital gains taxes (if the assets were sold immediately after death).

In 2010 the heirs only receive a step up on the first $2.6 million ($1.3 million from Rob and $1.3 million from Amanda) while paying capital gains (when sold) on the remaining $5.4 million.  Depending on the basis, that tax could easily exceed $450,000.

Where are we going?  In late December 2009, the House of Representatives passed a measure that would have frozen the estate tax exemption at $3.5 million with an estate tax rate of 45%.  However, the Senate failed to act on the measure.

Many individuals seem to think that the Senate will pass their version of the estate tax in 2010, reconciling the two versions later in the year and applying the law retroactively to January 1, 2010.  Congress may face some Constitutional challenges in trying to apply a law retroactively, but that is the prevailing thought right now.

Others seem to think that Congress will not do anything, allowing the estate tax law to reappear in 2011.

What should you do?  It still is important to have an estate plan in place.  Most individuals should have the five basic documents in place (revocable trust, will, durable power of attorney for property, durable power of attorney for health care and a health care directive).  You also should continue to talk to your attorney about the relevance of gifting, insurance planning and charitable planning.

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Robert Hehmeyer III, J.D.

Robert is the professional consultant for Steve Finerty and Linda Pietroburgo.