Estate Tax Update: How Will the Estate Tax Affect You?

It’s safe to die this year—but what about next year?

This year, some very wealthy people have died: Mitch Miller, George Steinbrenner, John Wooden, Senator Robert Byrd, General Alexander Haig, and Walter Frederick Morrison, inventor of the Frisbee.

What do they have in common, aside from their wealth? Their heirs will pay no federal estate taxes this year as a result of provisions in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Everyone expected Congress to pass legislation to establish new estate tax laws, effective 2010. They were too busy.

The Good News on Estate Taxes

For 2010, there are no federal estate taxes. Families will avoid IRS taxes as high as 55 percent.

The average person’s estate, with assets worth $1.3 million or less, will still get a stepped-up basis. That means the assets will be revalued to the fair market value at date of death (or six months later). This has two benefits:

1. You won’t have to dig up old records to prove the purchase price or cost adjustments for tax purposes.
2. When selling assets soon after death, you won’t have any capital gains taxes to pay.

A surviving spouse gets the same benefit on an additional $3 million worth of assets. For someone who dies in 2010 and leaves a surviving spouse, that means a total of $4.3 million will avoid both estate taxes and capital gains taxes.

The Bad News about Estate Taxes in 2010

There are a couple of negatives for people dealing with estates in 2010:

1. For all estates worth more than those limits, you will have to locate the purchase records for the assets. That can be nearly impossible. Consider stocks bought 30 or 40 years ago, which may have split several times, or been split up. (Though AT&T does offer help for the “Baby Bells” on its website.)

Strategy 1: You may decide which assets are excluded from estate tax. Assign the assets whose basis is hardest to establish to the excluded-asset list.

Strategy 2: Assign rental real estate to assets entitled to the stepped-up basis. You can start depreciating them all over again from their new fair market value.

2. To establish the new asset values, you will need to file paperwork with the IRS. However, the IRS has not designed the new forms yet, as of June 2010.

3. You will still need to file the Estate Tax Return, Form 706, with the IRS. There may be other returns, like the dead person’s final tax return (1040), a decedent’s trust return (Form 1041), and more.

4. State estate taxes didn’t disappear. Julie Garber, About.com’s Wills and Estate Planning guide, has an up-to-date list of states and estate tax exclusions.

5. The lifetime gift tax limit didn’t change. It’s still $1 million for all gifts over the annual exclusion amount ($13,000 in 2010). Beware of those advising you to make big gifts this year to get around next year’s return to the estate tax.

The Bad News about Estate Taxes in 2011

Unless there is new legislation, the estate tax exclusion will drop back down to $1 million on January 1, 2011. The top tax rate will be 55 percent plus a surtax for estates between $10,000,000 and $17,184,000.

TaxMama expects Congress to pass legislation on the estate tax to exclude assets below $3.5 million, effective next year. It will be permanent, indexed for inflation. But don’t hold your breath.

What’s the Estate Tax Bottom Line?

Get advice. If you have estate and death issues this year, you need to meet with a tax professional.

Eva Rosenberg, EA, is the publisher of TaxMama.com®, where your tax questions are answered. She teaches tax professionals how to represent you when you have tax problems. She is the author of several books and e-books, including Small Business Taxes Made Easy. Follow her on Twitter: @TaxMama

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