Most tax advisors thought that Congress would extend the estate tax before it was set to expire on December 31, 2009. They did not. What a mess Congress has created by their failure to act. For the first time since 1916, rich Americans can contemplate dying without one last “death tax”.
Although we have no estate tax, hold the cheers. First, repeal will only last thru 2010. And, to pay for this vacation from the estate tax, Congress has replaced the estate tax with increased income taxes. Before 2010, all assets that pass upon our death to our loved ones received a “stepped up basis” equal to their value at death; eliminating any potential “capital gains tax”. Now, under the 2010 law, only $1,300,000 of assets receives this new higher basis, and the remaining assets retain a “carryover basis” equal to the cost when they were purchased. Under the 2009 law, only estates above $3,500,000 were subject to estate taxes. So, while Congress is trying to get you to rejoice “no estate tax”, (which there probably wouldn’t have been estate taxes anyway) the IRS is coming in the back door to impose much higher capital gains tax. Bottom line, the new law is a definite break for the wealthy, (estimated to have been less then 5,500 estates in America in 2010) while placing a larger burden on the backs of perhaps 70,000 estates in 2010.
Estate planning attorneys and CPAs are hitting the books and traveling the seminar circuit to learn this new system of taxation referred to as “carryover basis”. And, to make matters worse, if Congress continues to do nothing, (which they are good at) we will have a 3rd tax system that will come into play in 2011 (the estate tax will revert back to 2001 laws, with only a $1 million exemption).
But, there is even a much larger problem than increased capital gains tax. You should not make the same mistake as Congress and “do nothing”. If you do, there may be unintended consequences that will occur in your Will or Trust if a death does occur while you are waiting for Congress to act. And, these unintended results will likely occur on estates that may be as low as $600,000, or even lower. The problem is that many estate plans have “formula allocation clauses” that allocate our assets between our spouse and perhaps our children based upon the federal estate tax exemption. Since there is no longer an “estate tax exemption”, these formula allocation clauses could work to pass all of your assets to your children, and your wife would be disinherited unintentionally (or vice versa). Some States, such as Virginia, are working on legislation that would prevent this unintended result. Arizona is not. It is imperative that you review your estate plans with your estate planning attorney, this year, to see if any of these formulas (which were very common) exist in your plan. Furthermore, pay attention to what Congress is doing on the tax issues. And, like most federal legislation, realize that the IRS is not going to give us a benefit unless they have a way to make up for it with other revenue somewhere else.