The Underworld Froze Over: Estate Tax Repeal is Here!

Honestly, I don't think anyone really saw this coming. Even the nerdiest of the Tax Law and Accounting nerds didn't think that Congress would actually allow the Estate Tax to be repealed. But Congress has. It's gone!

The Problem

First, the good news: If you (1) have a large estate (over $3.5 M), (2) you live in Utah (where we have no state inheritance taxes), and (3) you die in 2010 and before Congress changes the law, then all of your estate will pass to your heirs/beneficiaries free of Estate and Generation Skipping Transfer Taxes (GSTT), even without planning. Hooray!

Now the bad news: If your estate consists of a significant amount of property that has appreciated above what you originally paid for it

(land, stocks, small business interests, etc.), your heirs will most likely have to pay capital gains taxes on at least a portion of it when they turn around to sell it. Along with the repeal of the federal death tax, Congress also repealed the "full step-up in basis" rules that prevented most heirs from having to pay capital gains taxes on inherited property.

Still, Congress, in their boundless magnanimity (warning: sarcasm present), provided for a $1.3 M basis increase (for heirs other than a spouse) and a $3.0 M basis increase (for a surviving spouse) that can be applied to the tax basis of the property passing from the decedent at death. That takes away some of the sting. But the bottom line is that, for some families, these new rules could create an even greater tax liability upon the death of a family member (dying in 2010) than had they died on December 31, 2009 before the Estate Tax was repealed.

Example 1: John (30 year widower) dies on Dec. 31, 2009 with an estate consisting entirely of land purchased back in the 1950's for $1,000,000. Let's assume that the land had appreciated during that time to a value of $4.0 M. John's Will gives everything to his only daughter. Estate taxes due at his death would be approximately $230,000. If he died one day later in 2010, there would be no estate taxes due at all. But his daughter's tax basis in the land would be only $2.3 million (Dad's original basis of $1 M + $1.3 M basis increase available via Section 1022 of the Tax Code). Thus, $1.7 million would be taxed at a 15% long-term capital gains rate when the daughter sells the land ($1.7 M X 15% = $255,000). That's $25,000 more tax to Uncle Sam than before the repeal!

Two more problems:

(1) Congress could change the tax laws sometime this year and attempt to retroactively apply this tax to the estates of individuals dying between Jan. 1, 2010 and the date that Congress finally gets around to doing something about this mess. Many people feel strongly that doing so would be unconstitutional. Thus, there is a good chance that the question would be debated in the court system for years - all the while causing families to wonder if and when they will ever know how much they will ultimately inherit from their parents.

(2) If Congress continues to do what it does best (i.e., endlessly debate and accomplish nothing), the laws that are currently on the books provide that on January 1, 2011, the Estate Tax - and all those other things that got repealed along with it - will come back with a vengeance. In other words, if you die owning over $1 million dollars worth of property (this includes land, investments, life insurance proceeds, personal property, etc.) then anything over that $1 million dollars will be taxed at a 55% rate. Yes, you read that right. FIFTY-FIVE PERCENT!

Example 2: John's estate, from the above example, would have to pay approximately $1,650,000 in Estate Taxes.

What does the repeal mean for you?

Here's what you really need to know:

(1) If you (or your parents) have a trust in place, I would strongly encourage you to have an attorney who primarily deals with estate planning clients review your trust soon. There are many, many trusts out there right now that rely upon "fractional formula" planning that have the potential to create a lot of problems for the surviving spouse if only one spouse dies this year. Besides that, there are very few trusts that have included any provisions to take advantage of the new "carryover basis" rules that have just come into effect this year.

Also, don't fool yourself by thinking that "if it's important enough, my (or mom and dad's) old attorney will let me know." It is very uncommon for traditional estate planning attorneys to stay in contact with their past clients or inform them of changes like these. Sad, but true.

(2) If you don't have any estate planning in place, now is an excellent time to do so. With the threat of the Estate Tax exemption dropping to $1 M in less than a year, even very modest estates (after factoring in life insurance proceeds) could be taxed heavily upon the death of one or more of the spouses. A quality estate planning attorney will have the tools and knowledge necessary to handle the many different scenarios that could play out based on what Congress ultimately decides to do. This can translate into very large tax savings for you and your family.