Death may still be certain, but estate tax is up in the air
April 26, 2010
As Ben Franklin noted, nothing in life is certain except death and taxes. But when it comes to the federal estate tax—mocked by some as a "death tax"—all bets are off at the moment.
For the first time since 1916, there is no federal estate tax, at least as of April. The tax expired at the end of 2009—but unless Congress acts this year, it will be resurrected in 2011 at the higher rate of nearly a decade ago.
"This is a unique situation," said Michael Corr, a senior wealth planner with Vanguard Asset Management Services™. "With so much uncertainty around the estate tax, I'm recommending that our clients consult with their attorneys or tax advisors. Their wills may need to be updated to include language addressing different tax scenarios."
The uncertainty stems from a 2001 law that gradually reduced the estate tax rate to 45% from 55% and gradually increased the amount exempt from federal estate tax to $3.5 million from $1 million. The law also abolished the estate tax for 2010, only to reinstate it in 2011 at 55%—and restore the original $1 million exemption limit. Congress could restore the estate tax this year, including a fix retroactive to January 1. Or the tax could return in some other form next year. No one really knows.
Wealth transfer taxes in transition
| Year | Estate, gift, and generation-skipping transfer tax rate | Estate and generation-skipping transfer tax exemption | Gift tax exemption |
|---|---|---|---|
| 2009 | 45% | $3.5 million for each. | $1 million |
| 2010 | No estate tax or GSTT. Maximum gift tax rate is 35%. | Not applicable. | $1 million |
| 2011 | 55% | $1 million for each.* | $1 million |
* The GSTT exemption is subject to cost-of-living adjustments.
Source: Vanguard.
Capital gains tax may now hit harder
Meanwhile, Mr. Corr said, inheritances received from those who die in 2010 may have greater exposure to capital gains tax. In previous years, when a beneficiary sold inherited assets that appreciated in value after the benefactor's death, any gain was generally subject to the capital gains tax based on the assets' date-of-death value. Now, the capital gains tax could apply to the appreciation of the inherited asset based on the original price paid by the benefactor, including any adjustments over the years.
For example, a stock that cost $10 a share when bought decades earlier could be worth $100 this year. If the benefactor dies and the beneficiary sells now, he or she could be on the hook to pay capital gains tax on the $90 of appreciation.
However, current law generally allows assets inherited in 2010 to be revalued at a higher price (up to the date-of-death value) by the executor of the estate to reduce the potential tax hit. The allowable revaluation is reduced from prior years—generally, it can total up to $1.3 million, plus an additional $3 million for assets inherited by a surviving spouse.
Grandparents, grandchildren, and gifts
Further complicating matters, the generation-skipping transfer tax (GSTT) imposed on assets transferred to persons two or more generations removed (such as grandchildren) also expired on January 1 and is scheduled to be reinstated in 2011.
Meanwhile, the gift tax still exists. Under current law, a donor can give up to $13,000 annually to each recipient—and up to an additional $1 million over a lifetime—before paying this tax. Gifts over those thresholds are subject to the gift tax rate of 35% this year. Unless the law is updated, that rate goes up to 55% next year.
Note: All investments are subject to risk.