Estate Tax Planning Nearly Impossible For 2010
No one ever thought it would get this far.
Years ago, when then President George Bush proposed increasing the estate tax exclusion in stages, and eliminating the estate tax entirely in 2010, no one ever thought we’d get here without having some sort of permanent fix in place.
Back then, Congress put in place a 10-year plan to provide time to address the issues of lost revenue from the estate taxes. No matter which side of the isle your favorite politicians are on, they all thought something would be done before the 10 years were up.
And yet, we have arrived in the second month of 2010 with another big estate tax deadline looming: On January 1, 2011, the estate tax reverts to where it was in 2001.
Instead of figuring out how to treat the estates of those who die, Congress has been sidetracked with other issues, including the economic crisis, record unemployment, and health care reform.
Through the end of 2009, tax law provided each individual with a $3.5 million exemption from federal income tax and the generation-skipping transfer tax. Individuals were also entitled to a $1 million exemption from the federal gift tax, a top estate tax and gift tax rate of 45 percent.
The assets were given a full step-up in the basis, meaning that if you died owning a piece of property that you had purchased for $10,000 and it was now worth $1,000,000, the property’s value for computing a tax would be that value at or around the time of death.
If you die in 2010, however, your estate will pass down to your heirs’ estate tax free and generation-skipping transfer tax free. But the property you inherit will no longer have that stepped up basis, but rather the basis that it had when it was purchased. When you sell that property, you may owe capital gains tax on the difference in price between the cost basis and the sales price.
Here’s how it used to work: Up until the end of 2009, if you passed down property, your heirs would receive the property at its “stepped-up” basis, meaning that the property would be given the value on the date of death, rather than the date of purchase.
Because the stepped-up basis has been eliminated as of January 1, 2010, you’ll have to prove the basis for each asset. That could be tough if you’re inheriting your grandmother’s house that was purchased in 1945, and had several major additions and capital improvements made to it over the years.
The cost basis of property is the price that was paid plus the cost of major capital improvements. Could you, for example, prove how much your grandmother paid to redo her kitchen in the 1960s and 1990s? It could be tough if your grandmother’s estate can’t find any receipts.
The lesson here is to keep your receipts. If that $10,000 property had $990,000 worth of improvements, you wouldn’t pay any tax since the property’s value and the cost of the property plus improvements made to it over the years were the same. But without those receipts you might not be able to prove that the improvements were made and you may have to pay tax on the difference between the original purchase price and the sales price.
While the full basis step-up has been eliminated, but there remains a 35 percent tax on gifts above $1 million.
Pending legislation addresses jobs, highway construction through the end of 2010, and a tax cut for small businesses hiring some workers, but doesn’t include any permanent fix to the estate tax. If Congress doesn’t act, the estate tax and generation-skipping transfer taxes will return on January 1, 2011, but with only a $1 million exemption and a top tax rate of 55 percent for estate and gift taxes.
What does that mean for you? For many Americans, it won’t mean much. But if you die and have an estate, including life insurance, that exceeds $1,000,000, it will mean your heirs will have a big headache as you cope with an estate tax nightmare.
And here’s another quandary: What happens if someone dies before Congress enacts a fix for the estate tax mess?
Even if you die before Congress legislation is passed, the new tax laws could take effect as of January 1, 2010. For those whose estates quickly move to parcel out assets and file a final estate tax return, you may find the IRS asking the estate to refile and play by new rules – which could be nightmarish.
Estate tax experts say they expect to see legal challenges if Congress’ legislation forces the estates of those who die between January 1, 2010 and the date legislation to go back and live by the new rules.
If the legislation gets tied up in court, it could be several confusing years until the mess is straightened out.
What should you do now?
• Make sure you have a will. You never want a court to decide who gets your assets, or who will raise your children.
• Consider selling assets rather than leaving them to your children. If you sell your primary residence now, you will be able to take up to $250,000 in profits (up to $500,000 if you’re married) tax free. At the moment, that is a tax law you can count on.
• Pass down cash tax free. Current tax law permits you to give a gift of up to $13,000 per person each year, tax free.
• Fund up to five years of your grandchildren’s 529 college savings plans. You can put in five years’ worth of gifts in one fell swoop, effectively sheltering up to $65,000 per grandchild.
• Watch Congress for movement on the estate tax. Once Congress starts to move on this issue, you should meet with your tax advisor or estate attorney to discuss how you can protect your assets.