The Current State of the Estate Tax

Saturday, July 17, 2010

Currently, there is no federal estate tax. So, is that a good or a bad thing? The short answer is, no one really knows.

For anyone who isn't aware, in 2001, Congress changed the estate tax law so that the amount an estate could pass along tax free increased every year, until it reached a maximum in 2009. When 2010 rolled along, the tax was to be eliminated altogether, and then revert back to its 2001 incarnation in 2011.

At the time that the bill was passed, no one seriously thought that 2009 would come and go without Congress' passing a new law. The sunset provisions of the 2001 law were never really meant to go into effect.

More and more people are leaving behind larger estates, which in turn means that estate tax laws affect more and more people

Unfortunately, the current divisive climate in Washington has led Congress to commit what can only be described as malpractice by not addressing and resolving this very important issue. At no point in U.S. history have so many people owned their retirement assets, as the use of traditional pensions wanes and the use of tax deferred and employer sponsored retirement plans is on the rise.

Congress recognized this fact in 2001 when they raised the estate tax exemption from $650,000 to $1,000,000 topping out at $3,500,000 in 2009. Unfortunately, not resolving the sunset provision now may do two very bad things.

One, if Congress doesn't address the issue at all, estates that form in 2010 will escape the tax altogether, but starting in 2011, the exemption will fall back to $1,000,000. Even with the current economic downturn affecting portfolio values, that's a pretty small amount. It's even worse when you consider that the estate tax will be 45% for every dollar over the exemption.

Two, many people believe that even if Congress addresses the issue this year, if an estate was settled prior to the imposition of a new tax, they will not be affected. That may not be true. Congress almost certainly has the power to make a new estate tax retroactive to the beginning of the year. Lest anyone think that the Constitution prohibits the making of retroactive laws, that prohibition has only ever been held to apply to criminal laws.

What this means is that some estates settled in 2010 could be subjected to a very nasty surprise in the form of a retroactive tax. At this point it seems that the only real solution is for estate executors to set aside assets until the end of 2010 to pay any potential taxes. How much is anyone's guess, but it seems reasonable to use last year's exemption amount as a guide.

At 12:01 am on January 1, 2011, the new estate tax mandated by the 2001 law will kick in, and at least some measure of certainty will return. Until that time, if you are dealing with an estate that has even moderate assets, please exercise caution. Congress might still ruin your day.