"The only difference between death and
taxes is that death doesn't get worse every time Congress goes
into session." The implication in that old quip about life's
certainties was proved less than universally correct in
December of 2010, when Congress acted to raise the estate and
gift tax lifetime exemptions – for 2 years.
The 2010 tax law provides that for
calendar year 2011 and 2012, the gift and estate tax
exclusion, unified once again after being different for the
past 8 years, stands at $5 million. If the estate tax
exemption is not used by the first spouse to die, the estate
tax exemption available to the surviving spouse doubles to $10
million. That means that farmers, business owners and others
with substantial wealth can transfer significant wealth to
future generations tax-free.
Of course, you have to die in 2011 or
2012 to get the benefit of the new estate tax exclusion – you
can't plan for that. Thus the change in the law has limited
utility as a planning device.
The 2010 tax law also restores the
step-up in basis at death for estates of those dying in 2011
and 2012. Before 2010, the basis (the base from which capital
gains is computed) of all capital assets (stock, land, etc.)
stepped up at death to their fair market value. The net effect
was that inherited capital assets had no built-in gain – they
could be sold immediately without liability for capital gains
The "step-up" had been available until
2009, but since it was tied to the estate tax, when the latter
went away, the former was limited to $1.3 million of fair
market value. Instead of a full basis step-up for all assets,
the executor of the estate of someone dying in 2010 had to
allocate the allowed step-up to $1.3 million among the
estate's capital assets. An additional $3 million of basis
step-up could be allocated to capital assets passing to a
surviving spouse. That was more than enough to allow a full
step-up in basis in most estates, but for farmers, among
others, the limitation of basis step-up could actually result
in a greater tax liability for the heirs than the estate tax.
Confusingly, the 2010 tax law actually
applies to 2010 but provides that executors of estates of
persons dying in 2010 can "opt out" of it in order to avoid
the estate tax. This means that an executor can elect whether
to garner a full step-up in basis at the cost of exposure to
the estate tax, or take advantage of the elimination of the
estate tax and limit the basis step-up.
For most of us, this doesn't matter.
We can fit our entire estates under either the $5 million
estate tax exemption provided in the 2010 tax law, or the $1.3
million capital gains tax exemption under the prior law. But
for executors of estates of persons who died in 2010 with
assets in excess of $1.3 million, and for farmers and
landowners, business owners and successful investors who might
be exposed to the estate tax, a consultation with a tax
advisor is in order to determine the best course of action.
The $5 million gift tax exclusion
might actually be a trap, since gifts receive no step-up in
basis. The basis is "carried over" from the donor to the
recipient. Upon sale, the capital gains tax is figured from
the original basis upon purchase, and that might be higher
than the estate tax would have been if the asset had been
retained by the donor and bequeathed to the recipient under
the donor's will or trust.
For example, if Mom and Dad bought the
family farm for $300,000 from Granddad in 1950, then give it
to Son and Daughter in 2011 when it's worth $4 million, no
gift tax is due. But if Son and Daughter sell the farm after
Mom and Dad have died, the basis is $300,000, not the
stepped-up value as of the date Mom and Dad died. The net
capital gains tax cost can be crippling. Again, a trip to the
tax adviser is warranted to help the family decide whether the
estate tax avoidance is worth the capital gains tax exposure.
As ever in this column, no specific
advice is given. Consult with your planning professional to
see how the new law benefits you.