What Happens if the Federal Estate Tax Law Isn’t Changed this Year?

Estate Tax

There has been much recent discussion about “death” tax reform, and several bills have been introduced in Congress to that effect (as I have blogged about over the last few months), but so far the law as provided in the Economic Growth and Tax Relief Reconciliation Act of 2001(EGTRA) is still in effect.
EGTRA put into place the following estate tax “phase-out” schedule, which repeals the estate tax for a grand total of one year, and brings bring a $1 million exemption and 55% rate in 2011:

                             Top Estate          Exemption

Year                     Tax Rate             Amount

2002                      50%                      $1 million

2003                      49%                      $1 million

2004                      48%                      $1.5 million

2005                      47%                      $1.5 million

2006                      46%                      $2 million

2007                      45%                      $2 million

2008                      45%                      $2 million

2009                      45%                      $3.5 million

2010                      repealed                N/A

2011                      55%                      $1 million

GST Tax: the generation-skipping transfer tax rates and exemptions are the same. 


So, what happens in 2010 if the law isn’t changed later this year?

Partial Gift Tax Remains

Gifts in excess of a lifetime $1 million exemption would be subject to a gift tax equal to the top individual income tax rate at that time.

Modified Carryover Basis

A modified carryover basis rule will immediately come into effect. Under current law, the basis of assets received from a decedent is stepped up to the fair market value as of the date of death. Next year, the basis of assets received from a decedent will carry over from the decedent. Two exceptions will exempt most estates:

$1.3 million of basis can be added to certain assets and, in addition;

$3.0 million of basis can be added to assets transferred to a surviving spouse.

However, not all property is eligible for an increase in basis. Property acquired by a decedent by gift from a non-spouse within three years of death is excluded (to prevent “gifts” of low basis assets in exchange for stepped-up bequests). Income in respect of a decedent property (such as IRAs) is also excluded, along with stock held in a personal holding company or foreign investment company.

Impact of Modified Carryover Basis

Under the new rules, real estate or other assets that remain in a family for generations will require accurate basis records to be kept for generations as well. Without accurate basis records maintained over decades, the IRS will prevail in any dispute over the basis, thus keeping basis low and taxing the assets “artificially” high.

As a practical matter, the estate tax is being replaced with an increased capital gains tax for beneficiaries of estates over $1,300,000. 

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