Federal Estate Tax in Limbo for 2010

 It is 2010, and there is officially no Federal Estate Tax.  Why and for how long?  While the House recently passed a bill to reinstate the federal estate tax in 2010, U.S. Senators failed to reach a deal to temporarily extend the estate tax into 2010.  The extension proposed by the House would have kept the 2009 estate tax levels in place.  If the bill passed in the House becomes law, the first $3.5 million of an estate will be exempt from federal estate tax and the estate tax rate on the taxable portion of an estate would be 45%.  Senate Republicans want a permanent extension to a $5 million exemption and an estate tax rate of 35%.  If no compromise can be reached, we may continue with existing law.

Under the Economic Growth and Tax Relief Reconciliation Act of 2001, the federal estate tax exemption increased during the past decade from $1 million to its 2009 level of $3.5 million and the maximum rate decreased from 55 percent to 45 percent.   In 2010, there is a full repeal of the federal estate tax.  Starting in 2011, the federal exemption is scheduled to revert back to $1 million.

The lack of movement by Congress could cause a huge TAX headache for many of Ohio farm families if someone dies before a compromise can be reached.  This is mainly due to the fact there will be only a limited step-up in basis. Under current federal estate tax laws (prior to 2010), the assets of the deceased get a step-up (or step-down) in basis to the fair market value at date of death (or 6 months later).   The step-up simply means when heirs sell an inherited asset, they only owe capital gains tax on the asset’s appreciation from the day the asset was inherited to the date of sale rather than from the day the asset was originally purchased by the decedent. 

In 2010, if the federal estate tax remains repealed, the step-up in basis is limited to $1.3 million for the overall estate, plus $3 million for assets transferred to a surviving spouse.  The Executor will be able to add this extra basis to the existing basis of the property.  This means that Executors or heirs will have the added complexity of determining the prior basis of the property, which might go back many years or even generations. 

With the value of many of our farm estates, the lack of full basis step-up could trigger larger capital gains for farm families who inherit farm assets.  As a reminder, tax liability due to capital gain is not triggered until sale of the appreciated asset. If the asset is inherited this tax will not be assessed until later when and if the asset is sold.  It also may pass through another estate settlement (before it is sold) which may allow for the full step in basis if Congress passes legislation to allow such (as was allowed prior to 2010).  The tax assessed on capital gain is calculated on only the appreciated amount and currently is at a much lower rate (10 to 15%) than the federal estate tax rate.

So what is on the horizon?  It appears the full repeal of the federal estate tax in 2010 may be very short lived in 2010.  Senate Finance Chairman Max Baucus, D-Mont., and House Ways and Means Chairman Charles Rangel, D-N.Y., have said they will try to repeal the repeal and get the federal estate tax reinstated retroactively for 2010 after the New Year.  This will cause confusion, uncertainty and possibly very large tax headaches for those families who have someone pass between Jan 1, 2010 and whenever Congress reaches a compromise.  Families in that situation who are inheriting estates exceeding $3.5 million (or for whatever $ level the new federal estate will be) may be surprised when they owe a large federal estate tax bill if the law is changed retroactively.

This entry was written by David Marrison & Dr. James Skeeles, Extension Educator for OSU Extension and Russell N. Cunningham, OSBA Certified Specialist in Estate Planning, Trust and Probate Law (Barrett, Easterday, Cunningham & Eselgroth, LLP)


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