Thoughts on the Federal Estate Tax – Part I

Author: Lona L. Feldman Date: 10/17/2008

Categories: Estate Planning and Administration, Tax Services

During all of the pre-election discussions about taxes, one type of tax has failed to generate much interest in the media: the federal estate tax. However, this is of intense interest to any number of people in this area.

The federal estate tax is now an irrational amalgam of competing interests. Currently, each individual has an estate tax deduction of $2,000,000. Next year, each individual will have an estate tax deduction of $3,500,000. In 2010, the way the law is now written, there will be no limit to the amount of an individual can pass to anyone free of estate tax — but there will be no step up in basis for amounts over $1,300,000 for an individual’s assets left to his or her heirs (other than his or her spouse) in his or her estate. The decedent’s surviving spouse will be entitled to an additional aggregate basis increase of $3,000,000. The step-up in basis rules allow assets in a decedent’s estate to be valued at the decedent’s date of death, rather than the basis that is “carried over” from the decedent. For real property and other appreciating assets, this reduces and often eliminates any capital gains taxes. However, in 2011, under current law, the estate tax deduction falls back $1,000,000. This makes absolutely no sense.

Most practitioners believe that it is essential for Congress and the next president to address the estate tax before the irrational years of 2010 and 2011 are upon us. First, doing away with the step-up in basis rules for the year 2010 means that individuals who would have had no estate taxes and a full step up in basis in prior years will lose the step up in basis on some of their assets, thus paying significant capital gains taxes when these assets are sold. Second, most individuals have no idea what a decedent’s basis in particular assets would be. Accordingly, they may be taxed on the entire value of the asset since they would not be able to prove what the decedent paid for the asset. Third, in 2010, if you are very rich, you may need to hire a bodyguard since your heirs could do quite well if you just happened to die when there was no estate tax. Finally, how is it rational to have someone who dies on December 31, 2010 have no estate tax imposed on his or her estate, and yet if he or she dies on January 1, 2011, be entitled to only a $1,000,000 exemption from estate taxes?

All in all, this is an unacceptable scenario. We will be posting some ideas about potential estate tax changes in our next blog.