The Death of “Death Taxes”?

Now that the Republicans have won both houses in Congress, it seems inevitable that the federal estate tax (euphemistically referred to by many politicians as the “death tax”) will be repealed as early as next year. To accomplish this, Congress will likely extend the recent amendment to the Internal Revenue Code which eliminates the tax in 2010, only to have it reappear in 2011 and thereafter.

It is a bit strange that this issue resonated with the voters as well as it did since so few of them will ever be affected by it, especially in year 2009 and beyond when the personal exemption goes to $3,500,000 (which is effectively doubled for married couples). The number of people who die with estates of more than $7,000,000 is minuscule; and it seems that the larger the estate, the more likely it is that the decedent had a battery of financial consultants, accountants, and lawyers who have used sophisticated devices to avoid all estate taxes. A case in point is the estate of Walter Annenberg who died a multi-billionaire; it is reported that his estate will pay no estate tax since he left one-half of it to his wife (anything left to a spouse is tax-free) and the bulk of the rest of it to the Annenberg Foundation (which is tax-exempt as a gift to a charity). It is likely that as a part of the estate plan Mrs. Annenberg will leave the bulk of her estate to the Foundation as well.

What has not been so well publicized however is that Congress has made a change which will have a very broad impact on the heirs of many estates. Presently in the Internal Revenue Code there is a provision for stepped-up basis of appreciated assets at death. If the decedent had purchased a share of XYZ Corp. for $10, and at his death the share is selling for $100, the “basis” for tax purposes of his stock for his heirs would be not the original purchase price of $10 but $100 as a result of the stepped-up basis. If an heir were to sell the share for $100 there would be no capital gain tax under today’s law. Without the stepped-up basis in this illustration there would be a capital gain of $90 which would be taxable.

However, in the law that eliminates the estate tax in 2010, is a provision which also eliminates the stepped-up basis for estates with assets of $1,300,000 and more. While the heirs of the very smallest estates would still avoid paying capital gains taxes, there is now a limit; beyond that the heirs will find themselves paying taxes on the gain.

Assume a decedent has assets he or she purchased for $200,000 (for tax purposes, the basis), and at his or her death those assets are worth $2,000,000. The total purchase price ($200,000) would be added to $1,300,000, leaving assets with a new basis of $1,500,000. If the heirs then sell the assets for $2,000,000, a capital gain tax will be assessed against the difference, $500,000. This is a tax liability which does not exist today.

Given the enormous appreciation over the past 30 years of values in two of the most common investment vehicles, real estate and common stocks (even with Wall Street’s poor performance in the past two years), estates in the range of $1,500,000 to $4,000,000 are not uncommon. The heirs of such estates may find themselves paying substantial capital gains taxes as a trade-off for the elimination of estate taxes on much larger estates.

Congress has giveth and taketh away!

— Ken Butera

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