Tax Tips
FAQs on the Death of the Estate Tax
If Congress continues to do nothing about the federal estate tax, the levy will be back with a vengeance in 2011.
By Kevin McCormally, Editorial Director, Kiplinger.com
April 1, 2010
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Congress missed the deadline when it came to dealing with the federal estate tax. Despite more than eight years' notice, lawmakers allowed the estate tax to die on December 31. That levy -- which claimed 45% of the amount of an estate exceeding $3.5 million in 2009 -- has disappeared in a triumph for opponents who have long condemned the "death tax."
Although that might sound like cause for celebration, contain yourself. If Congress continues to do nothing, the estate tax will come back to life with a vengeance in 2011. As the law now stands, in 2011, just $1 million will pass to heirs tax-free, and bigger estates will be taxed at a top rate of 60%. What's more, a complicated new tax rule came into play on January 1 that requires some heirs to pay tax on profit from inherited assets that have long been tax-free.
At Kiplinger's, we expect that Congress will reinstate the estate tax and eliminate the complicated alternative. In the meantime, we've pulled together these questions and answers to help you navigate the treacherous waters ahead.
How did the rules work? A husband or wife could leave any amount to a spouse free of estate tax. For bequests to others, in 2009, everyone could leave assets of up to $3.5 million tax-free. Above that level, a 45% tax applied. The high exemption level meant few estates -- by one estimate, less than 15,000 -- actually owed the tax.
What replaces the estate tax for 2010? To understand the alternative, you must know the stepped-up basis rule. The old law set the tax basis of inherited assets at their value on the date of death of the owner. Because that new basis was generally higher than the owner's basis, the step-up effectively forgave the tax on any appreciation before the owner's death. If stock that someone bought for $10 was worth $100 when he or she died, $100 became the tax basis for the person who inherited the stock. The heir owed tax only if he or she sold the stock for more than $100.
As the law stands now, heirs are allowed to take a step-up in basis for only $1.3 million of appreciation. A surviving spouse can take an extra $3 million step-up. This means the tax can be forgiven on only $4.3 million of appreciation.
For any excess, in 2010, heirs are stuck with carry-over basis, meaning their basis is the same as the original owner's. When the heirs ultimately sell the assets, they'll pay tax on appreciation during the previous owner's life. In the example above, if you inherit that $100 stock, your basis would be $10, and you'd owe capital-gains tax on the $90 of appreciation when you sell. So the estate tax is being replaced by a capital-gains tax on some beneficiaries.
The executor is charged with deciding which assets get a stepped-up basis and which do not. The executor's decisions could lead to fights among heirs, some of whom will receive a tax break and some of whom may not. Another hellacious problem will be reconstructing the original owner's basis for the assets stuck with carryover basis.
Did the federal gift tax expire, too? That tax lives on, but at a lower rate. As in 2009, you can give up to $13,000 to any number of recipients each year without having to worry about the gift tax. For gifts above that amount, everyone has a credit that covers the tax on the first $1 million of gifts. For 2010, the top rate on taxable gifts is 35%, down from 45% last year.
What does Kiplinger's think will happen? We expect that Congress will retroactively reinstate the federal estate tax in a form similar to the law that applied for 2009. However, the exemption amount may be raised to as high as $5 million, and the top rate may fall from 45% last year to 35% going forward.
The U.S. Supreme Court has allowed retroactive tax changes. Congress frequently approves tax decreases retroactively. Although a law reinstating the estate tax would likely be challenged in court, we doubt such a challenge would prevail.
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Reader Comments (8)
Posted by: Frank Bruneel at 12/19/2009 06:04:30 PM
Do you thing Congress will extend the provision to allow pass through donations from 401K plans to charities and allow exclusion from taxable income?
Posted by: kevin mccormally at 12/20/2009 10:47:16 AM
Kevin McCormally of Kiplinger here, with an answer for Frank Bruneel. The rule that allows taxpayers age 70 1/2 and older to contribute up to $100,000 a year from their IRA -- not 401(k) -- to charity applies for 2009 but is scheduled to expire after this year. The House has passed an extension. The Senate has not and the odds seem slim they'll get around to it, especially how that Washington is buried in snow. (I'm looking out of my Capitol Hill window at 20 to 24 inches, but at least the sun has made an appearance this Sunday morning.) If the rule does expire, we expect Congress to re-enact it in 2010, retroactive to the beginning of the year. This is the kind of retroactive tax cut that the lawmakers often approve...because they can't get their work done in the time allotted.
Posted by: phat at 12/21/2009 10:41:46 AM
Living people pay their taxes all their life and why they still have to pay estate tax when they pass away? Why rate is too high? So if Bill Gate dies, our government will take more than 50 % of his assetS. What if rich people transfer all of their asset to the country has no such nonsense law? Who will be the loser at the end? U.S.A.??? Please advise, thank you.
Posted by: kevin mccormally at 12/22/2009 09:00:26 PM
Kevin McCormally at Kiplinger with an answer for Phat. One reason the rate is so high is that so much of an estate is tax-free. The estate tax rate actually starts at 18%, on the first $10,000 of a taxable estate. But, since the first $3.5 million is tax free, by the time the tax applies, the top rate -- now 45% -- is in effect. Fewer than 1/2 of 1% of estates are beg enough to be hit by the estate tax. And, for example, the tax wold not claim 45% of a $4 million estate but, rather, 45% of the $500,000 that exceeds the tax free amount.
Posted by: crashdamage1957 at 01/10/2010 07:13:42 PM
If the value of an estate exceeds 3.5 mil, would it not make sense to shove those assets into a irrevocable trust and thereby escape paying the estate tax ? I'm sure that there are downsides and other issues that shoudl be considered, but isnt this the reason that so few large estates actually pay taxes?
Posted by: Edgar at 02/12/2010 05:57:40 PM
There is some talk about a change/resurection to the Federal Estate Tax currently attached to a bill in Congress; does Kiplinger have any information/comment on this? Thanks for any info you could wish to share.
Posted by: Lynne W at 02/14/2010 12:38:26 PM
If a person died in Jan 2010, with some stocks in a Trust, do you have any advice on how the Trust should handle its distributions to beneficiaries / heirs? 1. Sell Stocks and distribute cash (does the Trust have the tax liability) 2. Distribute Shares (does each inheritor have to deal with tax liability?) 3. Hold / wait for now, and hope the stepped up basis is re-instituted retroactively.
Posted by: Tamara at 07/21/2010 09:24:09 PM
What is the deadline for Congress to make a retroactive estate tax change for 2010, is it December 31, 2010? Or could this uncertainty drag onto in to 2011?