Estate Tax Problem… no laughing matter

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Bloomberg BusinessWeek has published an interesting article titled “Mind the Estate Tax Gap.” The article focuses on some of the significant carryover basis issues under current law, suggesting that allocation questions fall to personal representatives and trustees, who face potential lawsuits from disgruntled heirs and penalties from IRS. Also, as has been said for some time, this presents a record-keeping nightmare. Imagine trying to track capital improvements to a home or determine all the stock splits that occurred in a stock over 50 years.

People have been making morbid jokes about bumping off their rich relatives in 2010, a year that has no federal estate tax, but few are laughing about it now. The tax is set to return, at a 55% rate, on January 1, 2011. While heirs of the ultra-rich who die this year may enjoy an estate tax break, this gap year is having unintended consequences. Far larger numbers of affluent families who suffer deaths this year could wind up paying stiff capital-gains taxes on inheritances. That’s because of the disappearance of what’s known as the “step-up” in basis, which allowed assets to be revalued to fair market value for income tax purposes at the time of death. Many people are going to be worse off than before.

Under last year’s rules, estates below $3.5 million (or $7 million for a couple) were exempt from the estate tax; people above those limits were hit with rates as high as 45%, but assets were revalued at the time of death, and “stepped up” to their full current value and not subject to capital-gains tax on past appreciation. When the estate tax went on hiatus, the “step-up in basis” rule for valuing assets went, too, so heirs are suddenly liable for capital gains on the past appreciation of assets they inherit and sell. For those who are bequeathed homes that have grown in value, family businesses that have expanded, or stocks that have risen in price, the old “step-up” rule let them start with a clean slate, owing no capital-gains taxes when they sold the assets. Not anymore.

A copy of the article can be found here.

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