Q: I heard that the Estate Tax was abolished. Is that true?
A: It’s complicated. The estate tax rules were overhauled by the Economic Growth and Tax Relief Reconciliation Act of 2001 (the Act). From 1987 through 1997, $600,000 of an estate was exempt from estate taxation. That gradually increased to $675,000 in 2000 and 2001.
The Act changed the taxation landscape. Beginning in 2002, the amount that could pass free of estate tax increased to $1 million, and gradually increased to $3.5 million in 2009. In 2010, there is no estate tax at all.
Congress seems to have been worried that abolishing the estate tax was not a good idea. Accordingly, in 2011, the estate tax automatically returns with a $1 million exemption. That way, Congress does not have to vote for a new tax, but could vote to abolish or liberalize the tax credit. I think they thought no one would notice the estate tax returning in light of the substantial increase in exemption amount for the period 2002 through 2010.
When the Act was passed, many thought the best estate plan would be to die in 2010. However, what Congress gave with one hand it took away with the other. Heirs of people dying prior to 2009 inherit assets with a step up in “basis”. Basis is an artificial concept for tax purposes. In simple terms, basis is what someone pays when they buy a property. It can be increased when you put additions into the property or buy other items allowed under the Tax Code. It can be decreased by such matters as depreciation, where allowed.
For assets inherited from people dying prior to 2010, the person inheriting the asset gets a step up in basis as if the person bought the asset for what it was worth at time the decedent died. When the recipient sells the asset, he or she will pay taxes on the difference between what it was worth at time the decedent died and what it is sold for.
That does not apply to assets inherited from people dying in 2010. For those assets, the beneficiary steps into the decedent’s shoes. In 2010, assets are inherited at the decedent’s basis. For assets purchased a long time ago or for assets which have been depreciated for tax purposes, that means the person inheriting the asset will face a huge capital gains tax when the asset is sold. That may exceed any estate tax that would have been paid had the decedent died prior to 2010.
The zero estate tax rate of 2010 can create other problems for those who have not kept up with their estate planning. Before 2010, there was an unlimited deduction for assets passing to a spouse. But, if the second to die owns more than can go to their beneficiaries tax free, a tax of 45 percent is applied.
A married couple owning more assets than could pass free of estate taxes often created estate planning documents under which each could give the maximum estate-tax-free amount to heirs other than their spouse, thereby doubling the estate tax exemption that would be applicable if they are second to die on all of their assets. That planning often involved creating a credit shelter trust when the first spouse died. Although the surviving spouse might get income from that trust, the IRS would consider it a gift to other beneficiaries and it would not be added to nor taxed in the estate of the second spouse to die.
However, many of those estate-planning documents contain form language which directs that the maximum tax-free amount that can be left to beneficiaries other than a spouse be placed in the credit shelter trust, and anything left over go to the surviving spouse. In 2009, that would mean the credit shelter trust would be funded with up to $3.5 million. In 2010, it likely means that all of the assets owned by the first spouse to die would go into that trust, and the surviving spouse would get nothing.
To make matters worse, most believe that Congress will pass new estate tax laws in 2010 and likely make them retroactive to January 1, 2010. That means people dying before the new tax laws are enacted will have no idea how the law will impact their estate and will have a real problem in tax planning.
The uncertainties surrounding estate tax law makes planning difficult, but not impossible. Those concerned with avoiding taxes and trying to pass as much as possible to their heirs should consult with their estate planning attorney soon. They should also be vigilant to follow changes in estate tax laws passed by Congress or ask for help in monitoring the changes. Although most believe that Congress will pass new legislation, that is not guaranteed. Contingency plans may be needed to account for current tax law and possible future changes. This is not an area that you should navigate alone.
William G. Morris is an attorney with offices at 247 North Collier Boulevard. His practice covers a broad range of subjects, including civil litigation, real estate, business and corporate law, estate planning and probate, domestic relations and contracts. He writes this column periodically with respect to legal matters that frequently affect non-lawyers. The information contained in this column is not intended as legal advice and, of necessity, is generalized. For questions about specific circumstances, the reader should consult a qualified attorney.