It's an extraordinarily uncertain time—tax wise, that is. This is the first year in decades that American tax law repealed the federal estate tax. As of Jan. 1, 2010, federal estate taxes are repealed for any deaths that occur during this calendar year, regardless of the size of that person's estate (state estate/inheritance taxes will still apply). In 2009, one could own $3.5 million in assets before federal estate taxes were assessed against the estate. For this year only, one can die with any amount of wealth and avoid estate taxes—yes, even Bill Gates. That sounds like a good thing for everyone, doesn't it? Actually, it could be a double-edged sword.
Could the Repeal Hurt Donors' Plans?
It might. In the past, most attorneys created estate plans that gave the surviving spouse an amount tied to what was above the amount exempt from estate taxes, using some type of formula clause. Because of the nature of the tax formula used in these plans and with an unlimited amount now exempt from estate taxes, the amount some surviving spouses inherit (aside from distributions from a credit shelter trust) could be $0.
An Additional Tax Is Imposed for Beneficiaries in 2010
A new tax shows up for those who are beneficiaries of estates in 2010. This tax is on the capital gains of assets such as stocks and real estate that occurred during the deceased's lifetime. If a beneficiary inherits these types of assets in 2010, the cost basis will be what the deceased originally paid for them (called carryover cost basis), and any growth will be taxed as capital gain to the beneficiary.
For example, Mary dies in 2010 and leaves her daughter 10,000 shares of stock she bought in 1981 for $50,000. Today the stock is worth $630,000. Mary's daughter inherits the shares with a cost basis of $50,000. So, if she later sells the stock for the current value of $630,000, Mary's daughter will have long-term capital gains of $580,000. At a 15 percent tax bracket, that equals $87,000 in tax.
Before 2010, if a beneficiary inherited stocks and real estate, he or she didn't have to pay capital gains tax on the growth that occurred during the deceased's lifetime. The beneficiary received a cost basis that increased to the value as of death (called stepped-up cost basis). If the beneficiary sold that asset right away for its current value, there would be no capital gains because the cost basis would equal the current value.
In the above example, the daughter would inherit the stock with a cost basis of $630,000. So, if she sold the stock for its current value, she would owe no capital gains tax.
A small reprieve exists in that the executor can increase the beneficiary's cost basis by up to $1.3 million and another $3 million for assets left to the surviving spouse. Regardless, many commentators believe this tax will affect more than 10 times the number of estates that were affected by estate taxes last year.
What Will 2011 Bring?
In 2011, federal estate taxes will reappear with tax rates up to 55 percent, and the exemption level for estate taxes will be $1 million. The carryover cost basis regime will go away, and a beneficiary's cost basis will again be equal to the asset's current value.
Could More Changes Take Place Yet This Year?
Congress still may change the laws before 2011 to reinstate estate taxes this year. The exemption level at which it will be reinstated is unknown. Congress may also rid the tax system of the carryover cost basis system for beneficiaries before the end of 2010. This may or may not happen, leaving Americans in a state of uncomfortable tax-limbo.
What Are Your Donors' Next Steps?
Encourage your donors to review their will or revocable living trust with their estate planning attorney as soon as possible to determine if any estate plan changes are needed to reflect the temporary repeal of the federal estate tax. The danger of not meeting with an attorney is possibly disinheriting their spouse.
For more information, contact Johni Hays at 800-331-6881, Ext. 219, or johnih@stelter.com.
