WHAT IS GOING TO HAPPEN WITH
THE FEDERAL ESTATE TAX EXEMPTION
By Michael J. Norton
For some time now, pundits have jokingly said that anyone with a net worth in excess of $1 million should plan on dying in 2010 so as to take advantage of the one year repeal of federal estate taxes. Current law exempts an estate, the value of which is $2 million in 2006, 2007, and 2008, or $3.5 million in 2009, from federal estate taxes also known as "death taxes." These "death taxes" are temporarily repealed in 2010. Then, in 2011, unless the Congress acts in the meantime, the exemption, known to most as the "unified credit," returns to $1 million.
The modern federal estate tax regime began in 1976 with the implementation of a unified system of wealth transfer taxes. This unified system consisted of three separate taxes: the estate tax, the gift tax, and the generation-skipping transfer (GST) tax. Estate and gift taxes are imposed on transfers made at death and during life, respectively. The GST tax is generally imposed on asset transfers that skip a generation, for example, a transfer from grandparents to grandchildren, about a specified exemption amount. These separate taxes were "de-coupled" a few years ago. For example, the gift tax exclusion has remained at $1,000,000 while the estate tax exclusion has risen to the current $2,000,000.
An important feature of the current estate tax system is the "step-up" in basis for transferred assets. Most know that the basis of an asset is used as its cost for the purpose of calculating capital gain. Under current law, the basis of an asset transferred by will to an heir is increased or stepped-up to its then current fair market value. The result is to exempt from capital gains taxation the amount of the step-up in basis or gain prior to the transfer to the heir. Unless the current law is changed, beginning in 2011, such transferred assets would be valued at what is called a "carry-over" basis; that is, the cost of the asset in the hands of the transferor decedent. This little known provision will have a huge impact on the transfer of wealth from older generations to younger generations in years to come unless it is changed by the Congress.
In May 2006, Congress' Joint Economic Committee examined arguments for and against the federal estate tax and concluded that its benefits are overstated and that "there is no compelling reason to keep the tax, and [there are] a number of reasons to reduce or abolish it." This study concluded that the current estate tax system, among other things
(a) impedes economic growth through high compliance costs and economic inefficiencies;
(b) hinders entry into self-employment and breaks up family-run businesses;
(c) is an "ineffective tool for fighting wealth and income inequality;" and
(d) results in an overstatement of the benefits of charitable gifts.
For months now, the Congress has been wrestling with what to do about this current law, including whether to enact a higher and perhaps permanent unified credit, and what to do about the potential train wreck if carry-over basis comes into effect. The President and some in Congress have supported outright repeal of the "death" taxes. Others in Congress have supported continuation, in some form, of an estate and gift tax regime. In recent weeks, it has appeared that a consensus has developed in Congress for a $5 million "unified credit." If enacted, all but a relative handful of estates would be exempted from federal estate taxes. The good news is that there are no Colorado state estate taxes at present.
Additionally, it has been reported that the government is moving to eliminate the jobs of nearly half the lawyers at the IRS who audit estate tax returns. Many outside the government view this effort as "a backdoor way for the Bush administration to achieve what it cannot get from Congress, which is repeal of the estate tax."
Michael J. Norton
For more information, please contact Michael J. Norton at (303)796-2626 or mnorton@bfw-law.com.
Mr. Norton is a senior member of the firm. His practice areas include complex civil litigation and white collar criminal defense, real estate law, including real estate broker and licensing law, and wills, trusts, and estate planning.
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