Benjamin Franklin noted that life’s only certainties are death and taxes. Most of the time, we just wait for them to intersect.
But unless Congress acts, the estate tax — the federal law that connects these two inevitabilities — will disappear, at least temporarily.
For some that could be a very good deal. For others, it could cost them money.
Should you worry about the estate tax or its impending demise? That depends. And is the law’s expiration even a valid concern? Probably not, but the timing of its return could be an issue.
Since the 1980s, the amount of an estate that is protected from taxation has increased while the tax rate applied to the amount over the exempt threshold has fallen. In 2009, an estate worth up to $3.5 million will not face any federal tax. The value of estates over that amount will be taxed at 45 percent.
The temporary end in 2010
If the law enacted during George W. Bush’s administration stands, when Jan. 1, 2010, rolls around, estates will not be taxed at all. That repeal, however, is slated to last just one year.
The estate tax will be back in 2011. Even scarier than its resurrection is that application of the tax will be at pre-2001 levels. That means that in 2011 only up to $1 million of an estate will be exempt from the tax. Assets in excess of $1 million will be taxed at 55 percent.
Anti-estate tax advocates say (jokingly we presume) the possibility of a tougher estate tax in 2011 will lead to “throw mama from the train” scenarios in 2010 where people or their families will make end-of-life decisions based on more favorable tax treatment.
Even the most cynical doubt there will be wholesale plug-pulling if the estate tax law continues as is. But the one-year repeal, or even the uncertainty about its repeal, is causing financial palpitations among taxpayers and their estate planners.
Get out your crystal ball
The top staff members of both tax-writing committees, Senate Finance and House Ways and Means, have publicly said they expect at least a short-term continuation of the estate tax next year. Tax watchers for the most part are taking them at their word.
“There’s a very good chance that Congress won’t allow the repeal to go into effect, that sometime before the end of the year they’ll do something to prevent the repeal,” says William E. Massey, senior tax analyst with the Tax & Accounting business of Thomson Reuters in New York City.
William Ahern, director of policy and communications at the Tax Foundation in Washington, D.C., is a bit more hesitant to predict action, at least any time soon.
“The conventional wisdom in the tax community is that a one-year repeal is intolerable and that the ’09 law will be extended and made permanent,” says Ahern. “But all the experts who say that will happen also are the ones who predicted that there would be some resolution of this long ago. But here we are, a quarter away from repeal of the estate tax.”
What could happen
When lawmakers finally get around to stopping the repeal as most believe will happen, what might we expect?
“They could keep the exempt amount at the current $3.5 million level, which seems to be the conventional wisdom, as a stopgap measure for one year to buy time. And there’s a good chance they’ll keep the tax rate at the 45 percent level,” says Massey. “But again, it’s very hard to know what they are going to do, especially long term.”
That 45 percent rate is quite appealing, fiscally for taxpayers who might face the estate tax and politically for the politicians who set it. It’s 10 percent lower than where it stood before the phase out began and where it will jump back to in 2011 if the law isn’t changed.
And all the talk during the health care debate about surtaxes on the wealthy has prompted some to look at that prospect when it comes to estates. “There’s a good chance we could see a surtax on estates at a higher level, say $10 million,” says Massey.
The basis bombshell
Another reason most believe the repeal will be stopped is the basis issue. Basis is the cost, or value, of an asset that is subtracted from its sales price to determine net profit. Tax then is generally due on that profit amount.
Under current law, when a person dies, basis in any bequeathed asset is “stepped-up” to its market value on the date of death. For example, your grandmother bought a stock for $10,000. To keep things simple, we’ll ignore things that could have added to the stock’s basis. She left you that stock, which on the day she passed away was worth $100,000. If you inherited the stock this year, your stepped-up basis would be $100,000. You could turn around and sell it for that amount and owe no tax.
But in with the estate tax repeal in 2010, carryover basis will be used instead. This would mean if you inherit your grandmother’s stock next year, you’ll also inherit her $10,000 basis in the asset.
Realizing the hit some heirs could take, tax law does allow for two types of basis adjustments in 2010: a $1.3 million aggregate basis increase and a $3 million spousal property basis increase. That year if you, as a nonspouse, inherit property worth more than $1.3 million, you’ll have to choose which of the assets you want to be included in the stepped-up basis allowance. You’ll owe tax on any other assets based on the original basis.
Those decisions and calculations could get very complicated. Or, says Eva Rosenberg, a Northridge, Calif., enrolled agent and editor of the Web’s Ask TaxMama newsletter, without the current full market-value-at-death step-up in basis, “life would a shambles.”
“We count on not selling certain assets because we don’t want to deal with it, where we have assets that were purchased years ago and we’re unable to determine the cost,” says Rosenberg. “It’s too expensive to figure that stuff out. Now if somebody dies, we have a way (stepped-up basis) to establish a tax basis for some things.”
And even with the basis options that will remain after the state tax’s repeal, some heirs of a $3.5 million or less estate that is now exempt from the tax could benefit more if the current law and full-market-value step-up system is retained, says Massey.
Ways and Means Committee Chief Tax Counsel John Buckley noted such situations at a Tax Governance Institute Web cast in September. The number of estates that would benefit from repeal is tiny, he said, when compared to those that would suffer from the loss of stepped-up basis.
Realizing that, it’s safe to assume that Congress will want to make sure the law benefits as many of their constituent taxpayers as possible.
Why Congress can wait
The big issue remains, however, as to when the estate tax repeal will be stopped. Congress is notorious for letting tax laws lapse and then reinstating them retroactively. Many argue that dealing with estate tax issues in that way would be difficult and possibly unconstitutional.
Not so, says Jeffrey N. Pennell, professor at Emory University Law School in Atlanta, Ga. A specialist in income tax, wealth transfer tax, trusts and estates and estate planning, Pennell’s treatise on the subject examines a unanimous 1994 Supreme Court decision that held a retroactive change to the estate tax was constitutional.
As for practical issues, an estate tax return generally is due nine months after the date of death. So, notes Pennell, that gives lawmakers until September 2010, the first filing due date for estates of those who pass away next January.
There also are some other reasons Congress might put off changing the estate tax law, says Pennell.
There could be some political gain on both sides of the aisle. “It’s probably tongue-in-cheek, but there are people who believe that Congress wants a chance to point fingers, place blame,” says Pennell. “Democrats can say to Republicans you created this mess so that come Jan. 1 we’ll have people pushing mama from the train. And Republicans can wag their fingers and say to Democrats you were in control and could have fixed it in a timely manner.”