Under the law as it is currently written, if a person dies this year (2010), no matter how wealthy, the person’s heirs will not be subject to the Federal Estate Tax. However, if a person lives until 2011, not only are the person’s heirs subject to the Federal Estate Tax, but the amount that is exempt from taxation, which was $3.5 million in 2009, will instead be $1 million. In addition, the highest marginal rate of taxation on an estate, which had been 45% in 2009, will increase to 55%, with an additional surcharge for mega-estates.
In other words, in 2011, if Congress does not act, the law reverts back to what is was before the Federal Estate Tax “repeal” statute was enacted in 2001. Generally speaking, if you die during 2010, the current repeal of the federal estate tax may prevent your assets from being distributed the way you intend.
In addition, the rules regarding “step up” in basis will change for 2010 if the law is not changed - the step-up in basis rule of the previous federal estate tax system has been replaced with a modified carry-over basis system for 2010.
The basis of an asset will determine how much gain (profit) is made when an asset is sold, and thus how much tax may be due. Higher basis means less gain, so less tax. Through 2009, for computation of capital gains tax on the sale of an asset, the tax basis of the asset of someone who dies is “stepped up” to fair market value at the date of death. However, for 2010, there will not be a universal “step up” in tax basis.
Part of this new system is an allowance of a specified amount of basis increase. This amount is in two parts: one part that can be allocated to assets for all beneficiaries (in the case of any estate, the aggregate basis increase is $1,300,000) and one part that is limited to qualifying assets passing to a surviving spouse (in the case of any estate, the aggregate spousal property basis increase is $3,000,000).
If Congress does not act, people with either substantial estates or with substantial assets with low tax bases must consider revising their wills and trusts to maximize the use of the step-up and to determine which beneficiaries should inherit stepped-up assets.