Before the battle of the Little Big Horn, Crazy Horse reportedly said to his men, “It’s a good day to die”. Estate tax pundits have been saying the same thing this year – it’s a good year to die. Why? Because the federal estate tax on the estate of a person who dies in 2010 has been repealed. If a person dies this year, then there is no federal estate tax due on what he or she leaves to his heirs. In an economy where the government is looking for every cent it can collect, this is an unusual situation. If we look behind the curtain at how we got to this point, we find the answer: Politics. In 2001, the federal estate tax (the tax at death on what a person owned) levied a 55% maximum tax on estates above $1 million. Estates below that amount did not pay a federal estate tax (though most states have some form of death tax). In May of 2001, Congress passed sweeping legislation that among other things gradually reduced and then eliminated the estate tax. By 2009, the highest rate had been reduced to 45%, and it applied only to estates over $3.5 million. Under the same 2001 law, in 2010, the estate tax is entirely repealed. But then in 2011, we wake up from this wonderful dream and find that the rates and exemptions have returned to the same levels that were in effect in 2001: a 55% maximum rate and a tax that applies to any estate over $1 million. That brings a lot of taxpayers back into the net.
I believe the thought at the time was that after the 2008 election cycle, the new Congress and new President would deal in some way with the issue. During the 2008 election, each candidate promoted a form of change that basically said “let’s leave things as they were in 2009” and “let’s move the exemption amount up a little higher”. However, since the 2008 election there have been other legislative priorities, and a divided Congress, and so no meaningful legislation has been advanced in this area. Because the 2001 law lapses, without any vote required, while the government forgoes the revenue that would have resulted from an estate tax in 2010, they then begin to collect higher revenues in 2011 and onward, because the rate is higher and applies to more estates. It is effectively a tax increase that no Congressman needs to vote on and defend in the Fall election.
So where does that leave us? The lame duck Congress or the next Congress could enact a new estate tax law – and conceivably could make it retroactive to cover deaths in 2010. Most commentators believe that at this date a retroactive law is unlikely. The estates of George Steinbrenner and the other wealthy people who die this year will likely go untaxed (at the federal level). A new law could implement the range of past proposals – adjusting the highest rate, and raising the dollar value of the exemption. Or, in a down economy, with declining revenues, the Congress can simply leave the law alone, collect the higher revenues, and blame the politicians of the past. No one thought we would get to this point, and so there is no certainty about what will happen next.
One of the inadvertent results of the elimination of the estate tax in 2010 is that certain assets in the estates of people who died this year will generate increased capital gains taxes for the government. Under previous law, if you had a highly appreciated asset – a stock that you bought for $10 and is now worth $100, if you sold it, you would pay tax on the gain – the difference between the sales price and the original purchase price (or “basis”). But if you died owning that stock, then at death the basis would “step up” to its value at date of death, $100, and if the stock was then distributed to the heir, who immediately sold it, the heir would pay no capital gain – he sold it at the same price as his basis in the stock, and so there would be no “gain” for income tax purposes. But with the elimination of the estate tax, there is no step up of basis, so the heir now acquires the asset at the previous $10 basis, and if he then sells it, he pays a capital gains tax on the $90 gain. This is another result that benefits the government, as the taxes resulting from this result to some extent ameliorate the loss of income in 2010 from the estate tax. Presumably when the estate tax goes back into effect in 2011, the step up basis rule is also restored, and so this is just a one year anomaly.
So how do you plan in this environment? It is very difficult to do so. If you thought your estate was well under the $3.5 million exemption amount, then you did not need to pay too much attention to estate tax planning. If the estate tax exemption falls to $1 million in 2011, then you may want to look at how this may affect you, and may want to consider some planning devices to minimize the federal estate taxes you may now have to pay.
©2010 Douglas P. Humes
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