Dear Clients and Friends:
You probably have seen reports in the media that the estate tax has been repealed. I am writing to explain what has happened and offer some suggestions. I am reminded of a quotation attributed to Mark Twain: "The reports of my death are greatly exaggerated." Please allow me to offer a more complete explanation of the demise of the estate tax. For decendents dying in this year, there is no Federal estate tax. Locally, the District of Columbia and Maryland retain their own tax systems with effective tax rates from 5.6% to 16% and a $1 million exemption. Virginia has no estate tax. Many other states retain some form of the tax. However, for decedents dying on January 1 or the next 364 days thereafter there will be no Federal estate tax.
Although at first blush it might appear
otherwise, repeal of the Federal estate tax is not a good thing.
- First,
it requires death in 2010. Repeal is temporary. Under existing law,
the estate tax returns in 2011 at pre-2002 rates and exemptions: a 55%
maximum Federal estate tax rate and a $1 million exemption.
- Second, welcome to the
world of carryover basis. For decedents
who died prior to this year, everything the decedent owned received a step-up
in basis to date of death value. The
surviving family can sell those shares of IBM that have been in the family for
decades and pay no capital gain tax. For
decedents who die in 2010, the surviving family is going to have to find the
financial records to establish the decedent’s basis. No records; no basis. 2010 revenue laws allow a basis increase of
$1.3 million for the decedent’s assets, and a $3 million basis increase for
some, but not all, bequests to a spouse.
Please allow me to illustrate what this means.
Example 1: Grandma dies
with a stock portfolio of $3.5 million on December 31, 2009. There is no Federal estate tax because the
2009 Federal estate tax exemption is $3.5 million. Grandma’s heirs sell everything. There is no capital gain tax. (The heirs benefit from a complete step-up in
basis. Financial records are not
required.)
Example 2: Grandma dies on January 1, 2010 with the same $3.5
million portfolio. There is no Federal
estate tax. (It’s repealed...
temporarily.) The heirs sell everything,
but after rifling Grandma’s house and calling banks and brokerage firms they
can find no financial records to confirm what Grandma paid for the investments
in her portfolio. Capital gains tax
after a $1.3 million basis adjustment at a blended state and Federal rate of
20% is $440,000.
- Third, if you think your
estate planning documents are complicated now, imagine what they will be like if
your estate plan must coordinate a state estate tax with a Federal capital
gains tax.
How did this happen? Any explanation would require unkind words
about a dysfunctional Congress and administrations both Republican and
Democratic. That is not what you pay me
for, so let’s go straight to what to do.
- First, don't die. (Good advice no matter what the tax circumstances.)
- Second, if you think you may not
survive the year, please contact me immediately. Your estate planning
documents need significant revisions unless Congress extends pre-2010
law (see the third bullet point below). We know what to do. It is not
going to be simple.
- Third, take a couple deep breaths,
pour yourself a drink, or do whatever helps you think rationally, and
avoid panic. Congress may yet fix this by extending the current estate
tax system with a $3.5 million exemption and a complete step-up in
basis through 2010. Wait thirty days if you can (see the second bullet
point above) and check back with me at that time. We'll know more.
Maybe there will be good news. Maybe not.
Happy New Year.
Best regards and (seriously) best wishes for a healthy and prosperous new year.