This year could mark a once-in-a-lifetime event for the estate tax. For the first time since 1915, the country does not have a federal estate tax because the tax was removed temporarily in 2010 as part of the 2001 tax law. This lapse in the law will allow heirs to escape a federal estate tax payment. One notable example is the estate of George Steinbrenner, owner of the New York Yankees, who died July 13 at the age of 80, leaving an estate with an estimated value of $1.15 billion, according to Forbes. If Steinbrenner had died in 2009, the first $3.5 million of the estate would have been exempt from the tax and the remainder taxed at a rate of 45%. But because he died in 2010, his heirs will avoid paying what could have been a $500 million bill for federal estate taxes.
Without Congressional action, the estate tax will return in 2011 with an exemption for estates of up to $1 million and with the maximum estate tax rate set at 55% for estates of higher value. According to the Urban-Brookings Tax Policy Center, if the $1 million exemption is in place for 2011, the number of taxable estates is expected to increase dramatically to 44,000 from 6,400.
Where will tax rates be in 2011? (if Bush tax cuts expire)
| 2010 | 2011 | |
| Ordinary income | 35% | 39.6% |
| Qualified dividends | 15% | 39.6% |
| LT capital gains | 15% | 39.6% |
| Estate | 0% | 55% |
| Gift | 35% | 55% |
Important changes to cost basis in 2010
In addition to the suspension of the estate tax this year, the “step-up” rules on cost basis for inherited assets that appreciated are no longer in effect as of 2010. Prior to this year, the tax code provided for an unlimited step-up in cost basis on appreciated assets. That is, when heirs inherited appreciated stock, the cost basis of the asset would generally be based on the value of the asset on the date of death. Without this rule, the inherited security is now valued at the original cost basis of the stock. Depending on how long the stock was held, this calculation could result in a significant difference in the appreciated value, setting the stage for a higher tax burden. Currently, any gains of capital assets within an estate above $1.3 million for non-spousal heirs and $3 million for spouses would be subject to a capital gains tax when the property is sold.
Proposals on Capitol Hill
In July, Senator Bernard Sanders introduced a bill, supported by the Obama Administration and many Democrats, that would restore the estate tax at the 2009 level, exempting estates worth up to $3.5 million from the tax and setting a rate of 45% for estates worth between $3.5 million and $10 million. The Responsible Estate Tax Act of 2010 (S.3533), also proposes higher rates for wealthier estates, with a 50% tax for estates worth between $10 million and $50 million, and 55% for those worth more than $50 million. The bill also includes a billionaire’s surtax of 10%. A similar version, H.R. 5764, was introduced in the House.
Senators Blanche Lincoln and Jon Kyl introduced a bipartisan proposal in July that would permanently set the estate tax rate at 35%, with a $5 million exemption amount phased in over 10 years and indexed for inflation. It would also provide a “stepped-up cost basis” for inherited assets.
Uncertainty remains around the future of the estate tax. It is likely that the estate tax will return in 2011, but it is still not known what the tax levels will be. Investors may want to meet now with their financial advisor about their estate plans to determine if modifications may be necessary.
More in: Estate and Wealth Transfer, Taxes