Could the Estate Tax Repeal Cost Your Family More?

Due to Congress's failure last year to pass a revised version of the 2001 estate tax bill or to extend 2009's rules of a $3.5 million exemption and 45% estate tax, the estate tax law expired on January 1. Thus, with the repeal (for now) of the federal estate tax for 2010, it is widely assumed that the estates of high net worth Americans who die this year will be exempt from estate taxation.

Not so fast. While that might be true for some, it is also true that beneficiaries who inherit appreciated assets this year may now face a capital gains tax.

Here’s why. When the estate tax law expired, so did a provision that allowed assets to be "stepped up" to their date-of-death value at the passing of the owner, thus avoiding the levying of a capital gains tax on the appreciation of those assets. Therefore, while the current law has no estate tax, it does tax assets that have appreciated above a $1.3 million exemption when sold by heirs.

This peculiar situation poses some challenges with respect to estate planning. While the demise of the 45% estate tax certainly would help some families more than a 15% capital gains tax would hurt them, for many other families the opposite is true.

According to the Tax Policy Center, this change will negatively affect the families of at least 50,000 taxpayers who die this year. In contrast, the old law affected only about 15,000 estates per year.

This fiendishly complex issue is discussed in a February 13, 2010, Wall Street Journal article, "Why No Estate Tax Could Be a Killer," that includes estimates showing who would be better off under last year's law versus this year's system. The author determined that heirs of estates with assets totaling between $1.3 and $4.3 million would have been better off last year, while those with larger estates will fare better this year.

This is a very interesting argument that is causing a lot of discussion. If your estate includes any low-basis assets, such as stocks, real estate or a family business, you should review your asset situation with your estate planning attorney to gain a clearer notion of how the current law will affect you. While this situation remains unresolved, you should avoid taking any irrevocable actions, such as distributing or selling major assets.