Tuesday, September 14, 2010

Estate Taxes

Estate taxes have really been in the news. I thought some of would get a kick out George's comments.

Tuesday, 14 September 2010

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Should I Die Now... or Live For Another Year?

May 20, 2010
By George E. Zola


If you could time your death, did you miss an opportunity by not dying in 2009 or will it be better to die in 2010? Should your death be postponed until 2011 and beyond? The answer to this question will depend upon your assets, the built-in capital gains in your assets, and your outlook on life.
I happen to think that a later death is always better than an earlier death and that death is a drastic step to take solely to save tax dollars. However, from a pure financial analysis, you may have been better off dying in 2009 if you had highly appreciated assets with huge built in capital gains. Death in 2010 may be preferred if you have an extremely large estate consisting of assets which have not appreciated greatly during the time you held them.

There’s an old saying that goes “there are only two certainties in life; death and taxes”. If you are talking about estate taxes, that saying couldn’t be farther from the truth. It seems like only yesterday (actually eight years ago) we were celebrating the repeal of the Federal Estate Tax only to discover upon reading the Bill that the repeal only applied to individuals dying in the year 2010. If Congress did not act to address the issue, there would be no estate tax in 2010 and the estate tax would be resurrected in 2011 at its original levels. This one gets me!

We were all assured by the talking heads (so called “experts”) that this would never happen. Long time readers of Dream Weaving may remember an article in Spring 2002 discussing the Federal Estate Tax which stated:
“What is the likelihood that the federal estate tax will be repealed? Nobody knows for sure, but with Congress looking for funds to reduce the size of the projected deficit and with states also looking for funds to meet their deficits, it may be doubtful that Congress will act to provide a tax reduction for the 1% of the estates which are required to file an estate tax return.”
Well, my calendar reads 2010 and is it really surprising that Congress has taken no action to address the uncertainty? So as of right now, there is no federal estate tax but do not be surprised to see Congress act during 2010 making the effective date for reinstating the estate tax retroactive to January 1, 2010.
The following table will compare the major changes in the federal estate tax provisions for the years 2009, 2010 and 2011:
2009 2010 2011 Federal exemption-1 $3,500,000.00 unlimited $1,000,000.00
Highest estate tax rate 45% none 55%
Gift tax exemption-2 $1,000,000.00 $1,000,000.00 $1,000,000.00
Gift tax rate 45% 35% 45%
Generation skip exemption-3 $3,500,000.00 unlimited $1,000,000.00
Generation skipping rate 45% None 55%
Basis adjustment-4 Non-spouse beneficiaries unlimited $1,300,000.00 unlimited
Spouse beneficiary unlimited $3,000,000.00 unlimited 1 The amount which can pass to a beneficiary other than spouse without imposition of tax. 2 Cumulative lifetime gifts exceeding annual exclusion amount $13,000.00 in 2010. 3 Assets passing to grandchildren’s generation or beyond. 4 Amount basis in assets is increased at the time of death.

Even if Congress does not address the estate tax uncertainty in 2010 and there is no tax, your heirs will still be facing a monster known as carryover basis. In prior years, the basis of the assets passing to your heirs was stepped up to the asset’s fair market value as of the date of death. Therefore, all of the built-in capital gains were eliminated at death.
In 2010, the stepped up basis adjustment will no longer be unlimited but will be limited to $1.3 million on assets going to a non-spouse and $3,000,000.00 for assets passing to a spouse. For example, if you have a piece of property which was originally purchased for $100,000.00 passing to your children at death having a $2,000,000.00 fair market value, the children’s basis in that property in 2009 would have been $2,000,000.00 and if the property was then sold for the fair market value of $2,000,000 there would have been no capital gains on the transaction.
If the same property passes in 2010, the children’s basis in the property will be $1,400,000.00 ($100,000 + $1,300,000) and if it’s sold for the fair market value, the $600,000 difference will be subject to capital gains tax. Your executor will need to allocate the basis adjustment between your assets on a newly-to-be-created form and he will need to know what your original basis was in the property at the time of death. Unless you have very good financial records, this is likely to create additional complexity to estate administration resulting in additional cost.
Carryover basis was attempted in the 1970’s and was a complete disaster. Carryover basis will disappear in 2011. This alone is reason to keep the life support plugged in for another year.
The clock is ticking on the likelihood for a fix to the estate tax to occur during 2010. There is considerable discussion about the possibility of the fix being made retroactive to the beginning of the year.
There is some precedent in history and some case law indicating that a retroactive application of the estate tax change would be held to be constitutional; however, the later we get into the year, the less likely it is that a change will occur and that the change will be made retroactive to the beginning of the year. The year 2010 is an election year and the closer we get to Election Day the less likely that any member of Congress will act on a bill that could be construed as a tax increase.
Given the uncertainty, what action should be taken now? One legal scholar, Jeffrey Pennell, stated in a recent article as follows:“Is there a clear avenue for action today? In many respects the answer is no, making the old adage wise. ‘If you don’t know what to do, then do nothing.’ Rather than seeming weak or defeatist, that advice could avoid action that might make a client’s situation worse than doing nothing.”
Right now the repeal will only apply to individuals dying in 2010 and then only if Congress does not make the change retroactive to the beginning of the year.
While I do not recommend doing nothing as an approach, I do recommend that you take small steps and do not do anything that cannot be undone if the rules all change.
You should review your estate planning documents because certain items can create an absolute disaster. The best example would be if you have a will or trust which leaves an amount equal to the maximum federal estate tax exemption to someone other than a spouse and the amount above the exemption to the spouse.
Since there is no federal estate tax in the year 2010, this plan will in effect disinherit your spouse and create hardships. Additionally, given the fact that we may be facing the carryover basis issue, it may be prudent to begin reviewing your financial information attempting to retrieve historical basis information on your current assets. This will assist your executor in the event that they are forced to complete the allocation form to determine your beneficiaries’’ basis in the assets they inherit.
Given the uncertainty over which direction Congress may go, this is not the time to panic and overreact by making a bad situation worse. Our primary goal in developing an estate plan is to be sure that the assets you have benefit the individuals you choose to and a secondary goal is to minimize the transfer tax related to those assets passing to the designated individuals.
Unfortunately, given the uncertainty of times, it is impossible to minimize the estate tax with any degree of comfort. Your estate plan can be redrafted to contemplate no federal estate tax only to have the work made useless by Congress reimposing the estate tax retroactive to the beginning of the year or by allowing it to reappear on its own in 2011. Even if you were to die prior to Congress re-imposing the federal estate tax, if the tax is made retroactive to the beginning of the year the tax would still apply.
Whatever actions you take you need to be sure that they can be undone once the level of uncertainty is reduced. Review your documents, ask questions of your advisors if you have concerns but don’t hire a hit man to take advantage of the current absence of a federal estate tax. I am reminded of a famous Doris Day song which went “que sera sera, whatever will be will be”. It is always better to die later rather than sooner, even if dying later may cost you some additional tax.
I am reminded of a famous Doris Day song which went "Que sera sera. whatever will be will be."
It is always better to die later rather than sooner, even if dying later may cost you some additional tax. - gez


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