Financial Wisdom

Estate Taxes Under The New Tax Law

Lots of Moving Parts

Estate taxes were one of the most controversial parts of the ongoing tax debate. There was support for total elimination, yet many were opposed to eliminating them for the extremely wealthy. In the end, political forces and a desire to keep the "cost of tax relief" lower resulted in a very unusual scheme for reducing estate taxes over time, then eliminating them and re-instating them. Many expect estate tax rules to be re-examined over the next several years and another round of changes.

For most individuals and families, the changes are good news and should probably prompt a review of estate plans to make sure any needed changes are made to take advantage of the changing rules. Estate taxation can be complex and the services of a qualified estate planning professional can be essential.

How do estate taxes work?
Generally, when someone dies, all of their assets are assumed to flow into their estate. The estate's value is then reduced by certain expenses (burial, etc.) and amounts transferred to a surviving spouse. The remainder is considered to be the "taxable estate" against which estate taxes are calculated. The calculated estate tax is then reduced by a tax credit to determine what is actually owed. For 2007, the top estate tax rate is 45% and the exemption created by the tax credit is $2,000,000. This means that for someone dying in 2006, if their estate (after expenses and transfers to a surviving spouse) is less than $2,000,000, there will be no estate taxes actually to be paid.

Since 2002, the estate tax rates have been coming down and the unified credit exemption amounts have been increasing. In 2010, the estate tax is completely eliminated. Then in 2011, the laws in effect on January 1, 2001 are back in force. All of this assumes that Congress takes no action in the meantime.

Estate Tax Rates and Exemption Under The 2001 Tax Act

Calendar Year
Estate Tax Exemption
Highest Tax Rate
$675,000 reverts to current law
55% reverts to current law

Another provision of the 2001 Tax Act is the elimination of the "stepped up cost basis" when certain assets are passed to a beneficiary, beginning in 2010. Currently, when an asset passes through an estate to a beneficiary, the tax basis for the beneficiary is the fair market value of the asset on the date of death of the decedent. This could cause severe record keeping problems and hopefully will be addressed by a future Congress.

What should you do?
For the rest of this decade, the rules will be changing. You need to make sure your estate plan takes these changing rules into account. If your current level of wealth is high enough to potentially subject your estate to taxation, a review of your plan by a qualified estate planning professional is essential. Even if your assets are not yet there, they will probably grow over the coming years and a review is a good idea. In addition to discussing the tax aspects of your estate plan, your advisor can also help you address the non-tax issues like bequests, an executor and various documents that could help relieve stress if the unforeseen happens.