Will the Estate Tax Disappear?

There is an interesting article in today's Wall Street Journal entitled "Will the Estate Tax Disappear?"  The author, Laura Sanders, talks about how, under current law, from January 1, 2010 through December 31, 2010, there will be no estate tax.  Starting on January 1, 2011, the estate tax comes back, and the exemption from estate taxes is reduced from the current level of $3,500,000 to $1,000,000. 

    What the Wall Street Journal article highlights is that if the estate tax disappears in 2010, then the step up in basis at date of death will disappear as well.  This is how Congress and the Bush administration made the 2001 tax reform act revenue neutral – so that the loss of revenues of the estate tax would be made up by the gain in revenue from the loss of the step up in basis.

    The Wall Street Journal article explains that if your grandmother left you stock selling for $75 a share on her date of death that she bought in 1970 for $2 a share, under current law, your cost basis in the stock would be $75.  Thus, if you sold the stock for $80.00 after your grandmother's death, your taxable gain would only be $5 per share.  However, if the step up in basis goes away, your cost basis would be $2, not $75, and you would have a tax bill based on a $78 gain, rather than on a $5 gain. 

    The Wall Street Journal article also notes that only 5,500 estates are subject to estate taxes every year.  In contrast, there are probably millions or tens of millions of people who would suffer by virtue of the loss of the step up in basis.  Moreover, the last time Congress tried to eliminate the step up in basis at death, it simply did not work because of recording keeping issues.  How would the grandchildren of a taxpayer have any way of proving what their deceased grandparent bought a stock for in 1972?  How would the IRS prove the same, or disprove the family’s claim? 

    Thus, it likely is the case that both the estate tax and the step up in basis will remain with us.  It is a matter of seeing what bill Congress passes and when Congress passes that bill.  Congress has until about September 2010 to take action in order to enable Congress to apply any change in the tax law retroactively to January 1, 2010.  An alternative approach is that there is a bill pending in Congress to extend the existing exemption of $3,500,000 through December 31, 2010 so that Congress can take up the issue next year without the pressure of a September deadline.  We will keep you posted on any new developments. 

Is it time to transfer assets from one generation to the next?

            An article in the October 3, 2009 Wall Street Journal, entitled “Transferring Wealth Via the Bank of Mom and Dad,” highlights the fact that the current economic and interest rate environment makes this a wonderful time to transfer assets from one generation to the next. 

            As I have been telling many people for months, we are in a perfect storm that can inure to the benefit of clients and their families.  Asset values are lower than they were in the past.  For most people, that’s very bad news, and it’s hard to put a good spin on the fact that so many people have lost so much wealth.  However, it also means that more assets can be given within the gift tax exemption limitations, or lower gift taxes can be paid on the transfer of assets. 

            There really are few reasons to incur and pay gift tax given the number of vehicles that can be used to structure transfers without incurring gift taxes.  Many of those structures are based on the ‘applicable federal rate,’ an interest rate artificially set by the government.  For transfers during October 2009, for example, a parent can make a fixed-rate loan to a child for as low as 2.63 percent for a nine-year term.  Thereafter, as the Wall Street Journal article points out, a portion of the interest on that loan could be forgiven on an annual basis.  Thus, there are incredible gifting opportunities that we may not see for many years to come, or at all in our lifetimes.

            Of course, the problem with parents making substantial gifts of assets at a time when the value of their assets has plummeted is that parents are concerned about whether they will have enough assets for themselves.  This is a legitimate concern that needs to be addressed whenever assets are going to be given away by parents - - even if the assets double in value from their current value.  To gift substantial amounts of property, the donor/parents must feel comfortable they themselves will have enough assets and income remaining to live a comfortable lifestyle.  We can do an asset and cash flow analysis for a donor to review, but if they are not comfortable, then, perfect storm or not, high interest rates or low interest rates, it does not matter because the parents will not want to part with their assets. 

            The article in the October 3, 2009 Wall Street Journal gives a good summary of a number of these issues, and thus, I recommend it to you.