Estate Tax Repeal?

Happy New Year (!) and welcome to your new estate tax-free world, sort of.

According to the federal law passed in 2001, the federal estate tax was repealed in its entirety on January 1, 2010. This means, simply, that Bill Gates could have passed away on January 2 leaving his multi-billion dollar estate to anyone, without paying a dime of estate tax. At least probably.

The problem is that Congress and the President have indicated their desire to avoid the estate tax repeal somehow. It is possible that a law is passed this year to retroactively extend the provisions of the law in effect in 2009 through 2010 (and perhaps beyond). In other words, they could pass a law during 2010 to provide that estate tax repeal never happened. (If this happened, we would probably see lawsuits by beneficiaries of estates that would have been tax free.)

Even if Congress does not change the law for 2010, we still have 2011 to deal with. Under federal law today, the estate tax will return on January 1, 2011 with a $1 million exemption amount and a 55% maximum rate (with an additional tax available for certain higher net worth individuals). This much lower exemption rate will catch many more people, making estate taxes an even bigger headache.

Two related issues: First, the income tax step-up basis rule is repealed for 2010. Under prior law, a beneficiary's basis in inherited property was the fair market value of the property on the date of the decedent's death; now, the beneficiary will receive the basis of the decedent (known as carry-over basis). For example, suppose Grandpa died in 2010 leaving you his house, for which he paid $60,000 but which is now worth $100,000. Under the 2009 law, you could have sold the home immediately without paying any income tax, because your basis in the home would have been $100,000. Under the 2010 law, you will have a $40,000 taxable gain. (As always, there are exceptions (such as for smaller estates) and other complications.)

Second, the federal gift tax was not repealed, although the maximum rate was dropped to 35%.

Bottom line: We may have more doubts than certainty. The big question is likely how (and when) to plan for 2011.