Estate and Gift Tax

On Dec. 10, 2010, President Obama signed into law the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010 (“2010 Act”). This sweeping legislation addressed many aspects of taxation, including the estate and gift tax rules.

For starters, it stipulated that the estates of persons who died in 2010 can elect not to have any federal estate tax apply. Or, they can elect to have a federal estate tax apply, but with a $5 million federal estate tax exemption and a maximum federal estate tax of 35 percent.

If you elect to not have the federal estate tax apply, then the basis in the assets passing from the decedents to the heirs would be a carry-over basis. That is, whatever Mom paid for the stock continues to be the basis of the stock in the hands of her heirs. If Mom bought IBM stock at $5 per share, and if IBM stock is trading at $148 per share when the heir sells it, then the heir would have to recognize $138 of capital gains on every share of stock that she sold.

Although the capital gains tax rate is less than the federal estate tax rate, this still could generate a significant amount of income tax to be paid by the beneficiary. However, if Mom’s estate chooses to be subject to the federal estate tax in 2010, then the basis in the assets inherited by the heirs is the fair market value at the date of Mom’s death. If Mom died when the IBM stock was trading at $148 per share and the heir sells the stock when it is trading at $158 per share, then the heir only would have to recognize capital gains on $10 per share.

Deciding whether to elect to have the federal estate tax apply for persons dying in 2010 requires a determination of how much capital gains tax might be assessed, as well as how much federal estate tax might be assessed. This becomes a very complex analysis.

The 2010 Act further provides that for the years, 2011 and 2012, there is a federal estate tax with a $5 million federal estate tax exemption at a maximum 35 percent tax rate. If the estates of people dying in 2011 and 2012 are less than $5 million, then there will be no federal estate tax to pay.

The 2010 Act terminates as of Dec. 31, 2012. For those dying in 2013, the rules from 2001 will go back into effect: a $1 million federal estate and gift tax exemption and a maximum tax rate of 55 percent. My guess is that Congress will struggle with its next short-term fix toward the end of 2012. We will keep you informed.