Volume 21 Issue 6 -- November/December 2009
“The reports of my death are greatly exaggerated,” Mark Twain said after hearing that an obituary for him was erroneously published in a newspaper. Apparently, reports of the death of the “death tax” or estate tax may also have been greatly exaggerated.
In 2001, we mockingly wrote a newsletter entitled “Don’t Die Now – Wait Until 2010” and criticized the seemingly absurd state of the law governing the estate tax or, as some critics prefer to call it, the “death tax.”
In case you have not been following this issue, here’s the current state of the law. Beginning January 1, 2010, the estate tax as we now know it is repealed, but only for 2010. If a person dies on December 31, 2009, the estate will be subject to estate tax if the estate exceeds $3.5 million at a rate not to exceed 45%.
If the same person manages to live on until January 1, 2010, there would be no estate tax, no matter how large the estate. For those unfortunate enough to live until January 1, 2011, the estate tax would come back with a vengeance, taxing all estates in excess of $1 million, with a tax rate up to 55%.
Were this not bad enough, there is another wrinkle. Carryover basis returns for one year, 2010. Except for a brief spell of lunacy in the late 1970s, assets received from a decedent have always received a step-up in basis.
This is how the step-up in basis works. Fred Furd Sr. died in 2009 owning a farm worth $4 million, which Fred originally bought for $100,000. Under the current rules, if his Dad willed Fred Furd Jr. his farm worth $4 million on the date of his Dad’s death, and Fred Jr. sells it for $4 million, there is no income tax on $4 million even though Fred Sr. paid only $100,000 for the farm. As the beneficiary of Fred Sr.’s estate, Fred Jr. receives a step-up in basis to the fair market value of the farm on the date of his Dad’s death.
If Fred, Sr., dies in 2010, however, a modified carryover basis rule will apply. Fred’s heirs will receive a basis equal to the lesser of Fred’s adjusted basis or the fair market value of the property at the time of death. In addition, there can be an additional basis increase on certain assets of up to $1.3 million ($3 million for “qualified” property passing to a surviving spouse).
Thus, if, however, Fred Sr. died in 2010 and wills the farm to his son Fred Jr., who sells it soon thereafter for $4 million, Fred Jr. may have a capital gain of $2,600,000 ($4 million less the cost basis of $100,000 and the basis increase of $1,300,000). Even at a 15% capital gains tax rate, the income tax may be $390,000.
Here, we assumed that we knew what Fred Sr. paid for the farm, but Fred’s heirs may not know this. Thus they could be forced to reconstruct what Fred Sr. paid for the farm as well as every improvement he made to the farm over the many years that he owned it. Since many owners of real estate and businesses have questionable or limited records about the amounts paid for assets and subsequent improvements, a return to carryover basis could lead to great problems.
During the late 1970’s, after Congress had adopted a similar carryover basis rule, heirs often found the basis reconstruction task extremely difficult, if not impossible. This was one of the principal factors that led to the eventual repeal of carryover basis then. Apparently, however, Congress has forgotten about those problems.
If Congress does not repeal the carryover basis rules scheduled to take effect on January 1, 2010, heirs could face different state and federal income tax basis rules for assets acquired from a decedent.
In early December 2009, the House of Representatives passed a bill that would kill the repeal of the estate tax and extend the current estate tax law permanently with a $3.5 million lifetime exemption amount ($7 million for married couples). The bill would also repeal the carryover basis rules.
Most commentators, however, believe that it is unlikely the Senate will adopt the House bill, at least in that form, and it is far from clear what, if anything, the Senate may do with respect to the estate tax before the end of 2009. Thus we approach 2010 with considerable uncertainty about the estate tax law for 2010 and beyond.
Regardless of what Congress may do, many states that have estate tax laws have already “de-coupled” their estate tax laws from the federal law, meaning that any changes to the federal law may not affect the state laws already in place. Thus even if Congress does nothing and the federal estate dies in 2010, state estate tax laws may live on.
If you have further questions about this, call Tax and Business Professionals.
By Tax and Business Professionals, Inc.
9837 Business Way
Manassas, VA 20110
While designed to be accurate, this publication is not intended to constitute the rendering of legal, accounting, or other professional services or to serve as a substitute for such services.
Redistribution or other commercial use of the material contained in Tax & Business Insights is expressly prohibited without the written permission of Tax and Business Professionals, Inc.