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Finally, the Estate Tax Dilemma Has Been Resolved

Here’s a familiar scene. At the beginning of last week, the estate tax dilemma still loomed unresolved. Sound familiar? It should since it was only a year ago that Congress passed a bill in a rush vote during the third week of December 2009 in hopes that the Senate would concur and new tax laws would be in effect for 2010. But that didn’t happen, and the estate tax effectively expired.

So in retrospect, was that good or bad? Well, just ask George Steinbrenner (or rather his heirs), owner of the New York Yankees, who died in July 2010. His timing couldn’t have been better from a taxation standpoint since his estate saved approximately $600 million in estate tax, according to a Wall Street Journal blog.

However, there may have been huge capital gains tax consequences as a result of his death that haven’t been made public. You see, when the estate tax disappeared for 2010, so did a little provision of the tax code often referred to as a “step-up in basis.

This provision allows certain capital property to have its cost basis “step-up” to the current value for the heirs upon the death of the owner. If the heirs sold the property for the value as of the date of the owner’s death, there would be no capital gains tax due. However, if the property owner sold the property prior to his or her death, capital gains tax would be owed. For a more detailed discussion of this, see my previous 12/11/09 blog post, The Estate Tax Dilemma is Over! Oh, REALLY?

Now, however, the government has passed the Tax Relief and Job Creation Act of 2010 and has resolved both the estate tax issue along with the capital gains step-up in basis—at least for the next two years. Here’s how it looks for 2011 and 2012.

The estate tax exemption has been raised to $5 million and the tax has settled in at 35% of someone’s net estate. Essentially, if you have an estate valued under $5M, there will be no estate tax due. If you have an estate between $5M and $10M and are married, a revocable trust can be set up to inexpensively and effectively double the exemption to $10M. However, if your estate is valued at $10M+ ($5M+ if you’re single), consult a professional who can guide you in the right direction. Otherwise, the tax still will be steep, and ultimately, unnecessary, since there are strategies that can help you reduce or even eliminate it.

The capital gains step-up in basis provision will be reinstated for 2011 and 2012, which is great news. Many of my sources expressed doubt about whether this provision would be reinstated since 2010 was the first time in history that the government ever altered it. The attitude seemed to be that “what the government taketh away may not be given back.” We sure are glad that this provision has been given back.

What are the practical implications of all this? First, have your estate plan reviewed and updated if necessary. For many readers, this could be as simple as having your living trust reviewed. Many folks established their trust in the early part of the century and have never had it reviewed, much less updated it. When their trust was established, the tax law had been drafted through 2010 and their estate plan (trust) could be set up appropriately.

However, that law has changed and your estate plan may very well need to change with it. Additionally, there are many other provisions that have changed in the recently-passed tax act that are beyond the scope of this article. Not keeping up-to-date with these changes may cost you a lot more later.

If you don’t plan accordingly, you might as well list the IRS as a primary beneficiary of your estate!

 

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