A blog post

What’s Going On With The Estate Tax in 2010?

Posted on the 11 February, 2010 at 8:30 am Written by in Taxes

Well, as of this writing, there is no estate tax. There is also no generation-skipping tax (GST). There is, however, a gift tax for 2010.

Yippee right? Not so quick. Let’s take a look at the basis carryover rules in place for 2010.

If one passed way in 2009, there was usually no need to file an estate tax return unless the estate exceeded $3.5 million. The basis in assets (as an example: P&G stock) was “stepped-up” to its value on the date of death. If something wasn’t as easy to value (say a second home in Clearwater, Florida), one would obtain an appraisal or equivalent. This meant that any appreciation in the asset went untaxed for income tax purposes.  OK, there were exceptions, the principal one being income in respect of a decedent, but we are talking in general here.

It’s a different game in 2010. For deaths after 12/31/09, property is transferred at the lower of its adjusted basis or its fair market value. This means that the property cannot be stepped-up but it can be stepped-down.  There are two exceptions:

(1)    Everybody gets to increase basis to fair market value by (up to) $1.3 million. If assets have appreciated by $700,000, then the step-up is limited to $700,000. If assets have appreciated by $2.3 million, then the executor has decisions to make, as the maximum step-up is $1.3 million.

(2)    An additional $3 million gets stepped-up if the property is passing to the surviving spouse.

Key thing here is that $1.3 million refers to the appreciation, not the total value of the property. One could have an estate of $2.2 million that has appreciation over $1.3 million. Likewise one could have an estate of $10.8 million that does not have appreciation of $1.3 million.

Note that an estate of $1.4 million now has to file a return in 2010. The House estimated that 6,000 estates would have filed under the old $(3.5 million, 45% rate) rules. More than 70,000 estates will have to file under the new (carryover basis) rules.

The generation-skipping tax goes away also. This guy (the “skip”) is the special forces of federal taxes. You do not want to meet him in the field. The skip applies when you try to pass wealth from one generation to another but skip at least one generation in doing so. The common example is a trust for the grandkids. This is a not a tax to laugh at, as it equals the estate tax and is payable in addition to the estate tax. Think about that for a second. This is one expensive tax.

Does anyone believe that these rules will continue indefinitely? Frankly, no. But they are the law as it stands right now. What if one dies now but Congress changes the law in July? Will the law be retroactive to January 1? It is not clear. The Supreme Court has allowed retroactive increases in tax rates, but this is different. There is no estate or skip tax as of this writing. This would be a retroactive imposition of a tax not just a tax rate.

If you are affected, you really should meet with an attorney who practices in this area. There truly are many things that can go wrong, depending on your situation. An example is the marital/bypass trust combination that is very common in wills. You may have heard this referred to as the A/B trusts. The idea is to fund the bypass trust to its maximum, as the estate tax credit offsets the bypass trust and voila – no estate tax. Any excess estate goes to the marital trust, as assets passing to a spouse (or to a QTIP trust) also trigger no estate tax. Problem? The bypass trust doesn’t know when to shutoff in 2010, as there is no estate tax and no estate tax credit. It therefore sucks up all the assets and leaves nothing left for the marital trust. If the bypass trust is going to the children of a first marriage and the marital trust is going to a second spouse, this could be bad.

One last note. What about the gift tax in 2010? It is still there. The rate has been reduced though. It is now 35%. It was 45% last year. You can still give way $13,000 to anyone you wish without it counting as a gift, though.