The Federal Estate Tax is Gone: What’s the Catch?

ANNE WARD, CFP®, CRPC®

Senior Advisor

JNBA Financial Advisors

Anne.Ward@jnba.com

www.jnba.com

Topic: Wealth Management

When the estate tax repeal was written into the Economic Growth and Tax Relief Act of 2001, many experts believed it would not come to pass.  In fact, even up to the final days of 2009, a bill failed in the Senate that intended to make the estate tax exemption of $3.5 million permanent.  Since that time, much of the focus has been on Healthcare reform and so the federal estate tax remains repealed.  Cynics believe that the estate tax will be reinstated, some say retroactively, to the beginning of 2010. However, the further we get into the year, the more unlikely this becomes.  If nothing is done, in 2011 the estate tax will be reinstated with a $1 million exemption, and a top estate tax rate of 55%. 

For individuals who die in 2010, there is currently NO federal estate tax due, although the state of MN has continued their estate tax exemption of only $1 million, and many other states have also deviated from the federal law to impose their own estate tax. 

Although it is true that the federal estate tax is gone, a new type of tax is taking over - capital gains tax.  In 2010, any individual who inherits assets receives a "carryover basis", which is equal to the decedent's adjusted cost basis, rather than the asset value being equal to the fair market value as of the decedent's date of death (or occasionally, the alternate value date 6 months later),as it has been in years past.  Essentially, any imbedded gains that were inside the asset continue to the beneficiary.  If there are imbedded losses, these cannot be passed on.

For many individuals, determining the cost basis of assets that have been owned for many years may prove daunting.  In the challenge of insufficient records, the IRS allows for a reasonable estimate. However, beginning in 2011, a new IRS reporting law requires financial services firms to accurately capture a customer's cost basis, and identify whether a sale has generated a long or short-term gain or loss. 

To help with the complications of identifying cost basis, everyone who dies this year is allowed to increase the cost basis of their assets by $1.3 million, unless the asset was received as a gift within three years of death. An additional $3.3 million of basis increase is allowed on assets passing to one's spouse at death.

So, given the questions surrounding a retroactive estate tax, and laws moving forward  - what should a person do to plan for this? For small estates (e.g. under $1 million), it is unlikely that the recent estate tax law change affects the estate plan from a tax standpoint, although it is always a good idea to revisit your estate plan every few years, or when life changes occur. 

For larger estates, the one year lapse may provide a brief opportunity to become more proactive in managing and reducing potential future estate tax exposure, and it may be beneficial to make changes, even if short-term in nature. As with all estate planning, seek legal counsel, preferably an attorney who specializes in estate planning, and a Financial Advisor skilled in working with high-net-worth individuals.