So says Representative Sander Levin. Ryan J. Donmoyer of BusinessWeek writes here that Congress may get to extending the Bush erea estate tax rate next month.

Excerpt from the article: Levin said the committee would begin work to retroactively reinstate a federal tax on multimillion-dollar estates that expired Dec. 31. The legislation would likely seek an extension of a 2009 law, which applied a 45 percent tax rate on the value of estates that exceeded $3.5 million per individual.

“The sooner we do it, the better,” Levin said. The lapse of the levy and a complicated capital gains tax that replaced it was making it hard for families to plan their affairs, he said.

What a mess Congress has created! We are now in a year where there is no federal estate tax – but hold the cheers.  Congress has substituted another method of taxation that will collect more taxes from many of our clients and families than the estate tax.  Additionally, as has been reported in the local and national press,[1] these changes will, for some, greatly alter the planned for and anticipated distributions among family members and heirs.

A brief review of the law will help explain why this is so significant.  The 2001 tax act, signed into law by President George W. Bush, gradually reduced the maximum rate of the federal estate tax (and the equally onerous generation-skipping transfer tax on transfers to grandchildren) from 55% to 45%.  It also gradually increased the amount of property that you could pass free of federal estate tax from $675,000 per person in 2001 to $3.5 million per person in 2009.  That means that with basic estate planning, a married couple could pass up to $7 million free of federal estate tax, if they both died in 2009.

Then, in 2010 only, the 2001 tax act repeals the estate tax.  But like a horror film character who just won’t die, under the existing law the estate tax returns again on January 1, 2011 – only at a much lower $1 million exemption and a higher maximum 55% tax rate!  This strange “now it’s gone, no it isn’t” effect is the result of a rule in Congress that attempts to limit budget deficits.

Paying for Estate Tax Repeal

To pay for this one-year vacation from the estate tax, Congress replaced the estate tax with an increased income tax.  Before 2010, any assets that pass to someone when you die would be valued at fair market value at the date of death. Thus after death, when a surviving spouse or heirs sold any assets (like securities or a home) that had increased in value, they would not have to pay income tax on any of that growth that occurred during your life.  (This is referred to as a “step-up in basis.”) For many heirs this means huge income tax savings, oftentimes tens of thousands of dollars or more.

But in 2010 property that passes at death does not automatically receive this step-up in basis.  Instead, each individual has a limited amount of property that can be “stepped-up” in value at the time of death.  Property that does not receive this step-up value will be subject to tax on all increase in value from the date you first acquired the property. This means that the property could be exposed to tens of thousands of dollars of income tax liability for your heirs!

Not surprisingly, these rules are convoluted and in many cases very different from the old law.  In fact, Congress attempted to institute a similar tax structure in the 1980s and it was repealed, retroactively, because it was too difficult to administer.  Because of past experience as well as the anticipated difficulties in calculating such a tax, the common belief was that Congress would change the law before January 1, 2010. But it didn’t.

How You Are Affected?

This law can affect you in several ways.  For married couples as well as single clients, we need to first make sure that your property will be divided according to your desires, and not dictated by Congress. For more than 50 years it has been common to use a written mathematical formula to divide the assets of a married couple when the first spouse dies to maximize estate tax savings. Likewise formulas have been used to provide funds for charitable causes and to benefit family and friends. Now, in 2010 when there is no estate tax, these formulas will not work. If a spouse is not your sole beneficiary (for example, if you have children from a prior marriage), the existing formula could result in the disinheritance or substantial reduction of resources provided for the surviving spouse.

What Should You Do?

You should have your estate plan reviewed and make any changes that are necessary for this law. You need to ensure that your property is positioned to receive the maximum step-up in basis increase available under current law.

There are two types of joint ownership, Joint Tenancy with Right of Survivorship (JTWROS) and Tenants in Common (TIC). Problems with JTWROS include postponement of probate until last tenancy, loss of the double step-up in tax basis, and outright distribution. Many couples take title to property by this method and don’t realize the potential consequences down the road. It’s important to remember that JTWROS does not avoid probate, it merely postpones it until the second spouse passes away.

Similarly, holding title as tenants in common, you also lose the double step-up in tax basis, and your property is subject to the estate plan of each tenant as well as probate for each tenant in the event that both parties do not have a comprehensive estate plan.

Here is another “solution” that might sound good at first, but ignores several important realities. For instance, what if the child in question is too immature to handle the responsibility of a large sum of money on his or her own? What if the child suffers a  severe financial setback that puts the inheritance at risk to creditors? What if the child marries a fortune-hunter, is addicted to drugs or  alcohol, gets divorced or remarried? In short, you may need to protect your children and heirs from their own poor decisions. A proper estate plan can make these worries disappear.

An “I love you” Will is one in which all the decedent’s assets have been left to the spouse.  On paper, it might seem to be a caring, thoughtful gesture, but the reality is quite different. That’s because such a Will simply passes the complex issues and problems associated with transferring and protecting wealth onto the spouse or other loved ones. An “I love you” Will creates more problems than it solves, particularly for future generations.  This type of estate plan can also fail to provide proper tax planning, costing the family thousand of dollars in unused tax exemptions available under the estate tax system.

If you die without a Will or some other form of estate planning, the state in which you reside and the IRS will simply make one for you. Of course, they have no interest in avoiding or reducing estate taxes, minimizing estate administration costs or protecting your family and legacy. The distribution of our assets will just be turned over to the Probate Court. The probate process is needlessly time consuming, frustrating and expensive. It is also open to the public, meaning creditors, predators or anyone else will have complete access to all information about your estate. For the vast majority of people, the benefits of a Will or other estate planning
tools far outweigh any initial costs.