New Federal Estate Tax: Who it hurts and who it helps

Let’s remember what Milton Friedman said about tax cuts, “I am in favor of cutting taxes under any circumstances and for any excuse, for any reason, whenever it’s possible.” Is this always true? Not when Congress eliminates the federal estate tax while limiting the step up in basis. Some families will be helped and many others will be hurt.

Read this Wall Street Journal article and learn who is hurt by this change. It could be some of your best clients.

Why No Estate Tax Could Be a Killer

By Laura Saunders, The Wall Street Journal, 2/13/2010

Congress shocked everyone by letting the estate tax lapse on Jan. 1.

Now, here is the real stunner: For many, the lapse actually will raise taxes.

Under last year’s law, estates up to $3.5 million, or $7 million for married couples, were exempt from federal tax. This year that law has been replaced by a fiendishly complex levy raising taxes on the assets of those with little as $1.3 million. It will affect the heirs of at least 50,000 U.S. taxpayers who die this year, whereas the old law affected only about 15,000 estates a year, according to the Tax Policy Center.

“The new system is far worse for many people who have assets between $1.3 million and $3.5 million,” says veteran estate lawyer Ronald Aucutt, of McGuire Woods.

This little-understood facet of the current law was enacted as part of a deal brokered in 2001 with the expectation Congress would never let the estate tax actually expire. It isn’t clear when, or even if, a badly polarized Congress will take up the estate tax this year.

Legal Challenges

If lawmakers do bring back the estate tax, that would bring another set of problems. Reinstatement of the tax retroactive to Jan. 1, which many advocate, will bring legal challenges from wealthy estates that could take years to resolve. But if some version of the old system isn’t reinstated, heirs of smaller estates will suffer.

To see what is at stake, consider how differently this year’s and last year’s regimes treat the same asset held by two fictional widows: Ms. Bentley has total assets of $20 million, while Ms. Subaru’s total is $2 million. Each owns a $110,000 block of the same stock bought for $10,000 years ago. This simplified example uses a block of stock, but its logic applies to all appreciated assets, including houses and land.

Under current law Ms. Bentley and her heirs prosper. If she dies this year and the stock is sold, her heirs will owe only a $15,000 capital-gains tax, whereas last year the same move would have incurred nearly $50,000 in estate tax. By contrast, Ms. Subaru’s heirs would have owed nothing last year because the estate was below the $3.5 million exemption. This year they would owe the same $15,000 capital-gains tax Ms. Bentley’s heirs do.

The reason: Under the old estate tax, assets could be written up to their full value at the death of the owner, and neither widow had to pay capital-gains tax on the $100,000 increase in the stock last year. But current law fully taxes gains while imposing no tax on estates. Quite simply, the demise of the 45% estate tax helps Ms. Bentley and her heirs more than the 15% tax on appreciation hurts them. For Ms. Subaru, the reverse is true.

Winners and Losers

Beth Shapiro Kaufman, an attorney with Caplin & Drysdale, made estimates showing who is better off under last year’s versus this year’s system. She found that heirs of estates with assets totaling between $1.3 and $4.3 million would often have been better off last year, while those with bigger estates will do better this year.

Current law does give some relief to heirs of smaller estates. All estates receive at least $1.3 million of exemption from the tax on appreciation. The executor can “cherry-pick” assets after death and assign the exemption to maximize its value.

But the law is full of traps and demands detailed record keeping. Experts are telling those affected to avoid irrevocable actions, like distributing or selling assets, while the situation remains unresolved.

Some hope that Congress will wind up doing what it did when a similar tax regime was tried in the late 1970s. It was repealed after an uproar, but the estates of those who died while the law was in flux got to choose which system to use.

Such an approach could avoid some ugly family situations. Last December, some wealthy people were kept alive until the estate tax lapsed in January. “But if the tax comes back,” says Mr. Aucutt, “Relatives might be tempted to pull the plug.”

Source: http://online.wsj.com/article/SB10001424052748703630404575053430667449198.html?mod=WSJ_article_RecentColumns

How can Congress solve this problem? I like the solution proposed in the article: let families choose between estate tax systems.

You better keep your clients up to date on what’s happening with the estate tax. Don’t wait for the annual review. And don’t let one of your competitors tell them about it first. You might lose a client.

On the other hand, you’d be doing your competitors’ clients a favor if YOU let them know what’s going on. One way would be to put on free public seminars on estate planning. Establish yourself as your city’s expert on estate planning. Take a look at my estate seminar system and you could be giving your first seminar in 30 days!