On your mark, get set, die! Just kidding! But if Congress fails to pass a new estate tax law by the end of this year, which seems likely, it means there will be no estate tax at all as 2010 begins. It's hard to imagine the super-rich agreeing to make planned exits from life's stage as the New Year unfolds. But the estate savings could be huge. And the plot twists for made-for-TV murder movies certainly could be enticing. I'm thinking Angela Lansbury and Colonel Mustard in the library.
[See Best Affordable Places to Retire.] Congressional leaders have said they plan to enact a retroactive fix early next year. This would remedy their inability to deal with the sunset provisions of a 2001 law that somehow snuck up on them. Of course, they also promised they would deal with this matter in 2009, so some skepticism about their credibility might be in order. Everything in Congress is partisan these days, and estate taxation evokes ideological passions.
Estate taxes have been easing since the 2001 law was enacted. The exemption from estate taxes in 2009 is $3.5 million ($7 million for a couple), and the tax rate on the excess amounts is 45 percent. When assets are conveyed to heirs, they are valued at the time of the estate holder's death, not when they were purchased. This reduces capital gains taxes for heirs and, equally important, avoids the extensive paperwork of documenting the change in values of stocks and other holdings over the years.
Losing the estate tax altogether in 2010 might seem like a good deal for the nation's most wealthy families. But an even larger pool of taxpayers might get an unpleasant surprise. That's because the value of assets in 2010 estates would be set, for tax purposes, at their level when they were originally acquired. This provision also would trigger capital gains taxes for any estate larger than $1.3 million (another $3 million could be provided to a spouse without triggering capital gains). It would affect a projected 71,000 estates in 2010, according to a Congressional Joint Committee on Taxation estimate.
The changes do not only affect people who pass away in 2010, notes Jack Nuckolls, director of private client tax services at the accounting firm BDO Seidman. There also are changes in gift tax rates, which are 45 percent in 2009 but will be reduced to 35 percent if estate taxes lapse in 2010. Many wealthy people like to give away assets to their heirs when they're still alive. It can be a sound way to reduce later estate taxes, and any taxes on the rising values of such assets would be taxed at the heirs' tax rate, which presumably would be lower than for their benefactor. There is a lifetime gift tax exemption of $1 million; anything over that is taxed.
[See Best Places to Retire.] The intriguing question, Nuckolls poses, is what happens to people who either make large gifts or pass away between the first of the year and the date when Congress acts on a retroactive law. Would these people be forced to adhere to any new tax treatments enacted by Congress or could they use the provisions in effect at the time their assets were conveyed?
"No one in my industry has spent a lot of time with this, because no one thought it would happen," Nuckolls says. But he predicts that financial advisers, estate attorneys, and wealthy families will face a quandary in whether, or even how, to change estate plans. He's especially worried about the complex documents that are produced for such plans. The documents usually are based on provisions keyed to current estate rules and might be impossible to interpret in the absence of such rules. "The meaning of the terms in these documents is based on an understanding of estate rules that are no longer in effect," he says. "If you're wealthy, then your estate plan may make no sense because there is no estate tax."
"Retroactive fixes to an estate plan are just a nightmare," he adds. Estate executors, for example, have legal responsibilities to protect the value of assets in an estate. If there is a retroactive fix that reimposes an estate tax, Nuckolls says, some executors may conclude they have no choice but to retain legal counsel and seek a zero tax treatment if there was no estate tax on the date an estate holder died.
Similarly, for gift taxes, the lower tax rate in effect as 2010 begins also might prompt legal challenges to a retroactive law. "Why wouldn't you" claim the lower tax rate, he asks. "You might just be buying yourself a lawsuit, but who knows what will happen?"
While Nuckolls would like to feel confident that these matters will somehow be resolved as 2010 unfolds, his greatest fear is that Congress fails to act next year as well. If that were the case, estate taxes would return in 2011 with terms rolled back to where they were when the 2001 law was passed—only a $1 million exemption and a top tax rate of 55 percent.