'Death' tax takes a holiday

March 7, 2010
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Death and taxes aren't always certain, at least not this year.

The U.S. Congress repealed the Federal Estate Tax for 2010 as part of the Economic Growth and Tax Reconciliation Act of 2001, the first of two tax cuts the Republican-led chambers passed during the first term of the Bush administration. In the most basic sense, the tax is rescinded for this year because the exemption ceiling was eliminated, which means there is no income for the Internal Revenue Service to collect. So individuals in the higher income brackets who die this year can leave their entire estates to their heirs without paying a cent of what Republicans have labeled the "death" tax.

Next year, though, could mark a taxing return to the past.

"We went from a position in 2009 where estates over $3.5 million were subject to a rate of up to 45 percent. In 2010, there is zero estate tax, essentially. And if nothing is done in 2011, the rates and the taxable amount will go back to the 2001 levels, which was, all estates over $1 million were subject to a tax up to a rate as much as 55 percent," said Mark Yost, a partner at Ernst & Young.

The House passed legislation late last year that would have returned the tax's exemption and top rate to the 2009 levels. The Senate, however, rejected the bill.

Due to the Senate's action, the targeted top rate for next year is 55 percent instead of 2009's 45 percent. The exemption for 2011 is $1 million instead of the $3.5 million exclusion that was in force last year.

Others in Congress are reportedly attempting to change the tax for this year.

"There still is some consideration being given to try to enact some legislation this year that would be retroactive back to Jan. 1 to initiate that kind of estate tax," said Post, who has been with Ernst & Young for 32 years.

But reverting back to the 2009 exemption and rates this year could be difficult, if not impossible, for two reasons. One, Congressional members have their attention turned to creating jobs, pumping up the recession-riddled economy, reforming health care and running for re-election. Two, it's already March, and the heirs of wealthy individuals who have died since the beginning of the year are likely to feel they're entitled to the unlimited exemption that is in effect for this year.

"You have the political issue and even, quite frankly, probably a legal issue as to whether you can retroactively go back and subject an estate of someone who has passed away earlier this year under a law where there was no estate tax, and all of a sudden go to their heirs and say, 'Wait a minute, you owe us so much money because we changed the law retroactively on you,'" said Post.

"Not only would that be a political minefield, but I don't know legally how that would stand up in court. So they've got that issue. And because Congress is focused on health care, jobs and other issues with the economy, the longer it goes, the harder it will be to reach back to Jan. 1 to make something retroactive."

In addition to the top estate tax rate rising to 55 percent next year, which generally affects the top 2 percent of the nation's wealthiest individuals, the top two income tax rates will also go up, from 33 to 36 percent and from 35 to 39.6 percent in 2011, if Congress does nothing.

"I would like to think that something will get done this year to put something in place that is more amenable to the economy that we're in and everything else, but I don't know. I really don't. We thought health care was going to get done six months ago, so who knows," said Post.

Even if Congress doesn't take action on the estate tax for next year, the U.S. tax code offers individuals some options to reduce the tax's impact. These include Qualified Terminable Interest Property Trusts and reverse Q-TIPS, generation-skipping trusts, bypass or family trusts, and even traditional and Roth IRAs that estate planners can explain.

But no matter what year it is, an individual can escape the tax completely by leaving the taxable portion of an estate to a qualified charitable organization.

"Charitable transfers out of someone's estate, any bequests or gifts to charity, are not subject to the estate tax," said Post. "So that is an exception."

How the ‘death’ tax has evolved

Over the past decade, the estate tax exemption has risen while the top tax rate has fallen. Here is a yearly snapshot of that change, along with a peek at where the exemption and rate is set to go next year if Congress doesn’t alter the estate tax this year.


Year

2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011

Estate Tax
Exemption

$1,000,000
$1,000,000
$1,000,000
$1,500,000
$1,500,000
$2,000,000
$2,000,000
$2,000,000
$3,500,000
Unlimited
$1,000,000

Estate
Tax Rate
55%
50%
49%
48%
47%
46%
45%
45%
45%

55%

Source: About.com: Understanding Estate Taxes, February 2010

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