Keeping Death Waiting

Congratulations to the U.S. Congress!  It has managed to do what human beings have been trying to accomplish since we first appeared on this Earth: put death on hold.

Not biologically, of course.  Just legally.

Come Jan. 1, individuals who die and leave assets behind have no idea how what, if any, estate tax their kids and grandkids will have to pay.  The thousands of dollars they spent to have wills and trusts drawn up could all be wasted money.

And it’s all because Congress can’t get its act together.

It started back in 2001 when the “Economic Growth and Tax Relief Reconciliation Act” was passed, ushering in the most significant tax changes in decades. Among other things, EGTRRA reduced income tax rates, slashed capital gains taxes, increased the amount you can contribute to IRAs and employer-sponsored retirement accounts, expanded the ability to combine retirement account balances, and made certain withdrawals from 529 college savings plans federally tax-free. It also radically changed “transfer” taxes.

A “transfer tax” is the federal tax you pay when you transfer ownership of assets - stocks, bonds, jewelry, real estate, the small business your parents started - to someone else. When the transfer occurs because of a death, it’s called an “estate tax.”  If you transfer the property while you’re alive, it’s called a “gift” tax.

When EGTRRA was enacted back in 2001, the estate tax kicked in once the property left behind at death exceeded $675,000. Estates worth this amount or less were exempt from the so-called “death” tax. Thus, $675,000 was known as the “exemption” amount.  At the time, the top tax rate your estate might pay was 55%.

Beginning in 2002 the “exemption amount,” that is, the amount of property you could transfer at your death free of tax, has been rising. This year it hit $3.5 million, $7 million for couples. At the same time, the top estate tax rate has been declining. It’s currently 45%.

In addition, the special tax on property left to grandchildren (known as “generation-skipping transfer tax”) has also been declining.

On January first, the estate tax and GST disappear. But rather than celebrating, many estate planning attorneys and their clients are having nightmares. That’s because a new requirement is introduced: “carry-over basis.”  In a nutshell, this requires heirs to document the original price paid for the property they inherit and pay tax on the gain.(1)  “It’s a hugeproblem,” says estate planning attorney Eric Pfeil, a director at the firm Cohen and Grigsby in Pittsburgh. “People aren’t detail-oriented.”

For instance, how can you possibly know what grandpa paid for the summer cottage on Lake Michigan back in the 50’s, that your mother inherited in the 70’s, and you inherited from her in 2010?  Or, as Pfeil says, what about “the stocks your grandfather gave you when you were ten years old that his father gave him? The burden is on youto track this.”  In many cases, it’s impossible to know, much less prove, this.

Couples in second-marriages are also left in limbo, according to Pfeil.  If, say, a husband wanted to leave property to his children from his first marriage free of estate tax, he’d set up a trust equal to the exemption amount and leave the rest to his current wife. (A spouse never pays estate tax on inherited property.)

The problem is, if there’s no estate tax in 2010, then your entire estate, no matter how large it is, avoids estate tax.  In the above example, if the law isn’t changed and the husband dies next year, all of the property the husband owns could end up going to his kids. He would end up disinheriting his spouse!

But, wait.  There’s more.

The changes outlined above are only in effect for one year.That’s because EGTRRA included a self-destruct, or “sunset,” clause that cancels all of the changes it introduced. In 2011, we revert back to the rules in place before the Act was passed, including higher tax rates on transferred property and lower “exemption” amounts. Thus, all of the planning folks have done - and paid for - since 2001 becomes useless.


Ever since the Democrats won back control of Congress, they’ve been warning they intend to “fix” the uncertainty over the estate tax. Earlier this month the House of Representatives voted to eliminate the one-year repeal of the tax and make the current (2009) rules permanent. But the Senate never got around to debating the issue.

Of course, at some point Congress might get around the settling the estate tax question next year. But it’s threatening to make the rules retroactiveto January 1st. So if grandpa dies in February when the old rules are in effect and the law is changed in June, his heirs may face a big tax bill that grandpa never intended them to pay.

Before you think, “Who cares? This only affects really rich people,” keep in mind that one of the main reasons the estate tax was changed at all was to keep folks from having to sell the farm or small business that had been in their family for generations in order to pay the estate tax when they inherited it.

Estate planners and financial advisors never thought Congress would let things come to this.  They figured that at some point in the past eight years the uncertainty would get resolved, there’d be clarity.

Instead, there’s chaos.

“There’s no economic reality to what people are doing today with regard to estate planning thanks to the crazy [tax] rates and current system of estate tax,” according to Pheil.  “For the past several years we’ve been building our houses on shifting sands.”

On January 1, 2010 that becomes quicksand.

Is this any way to run a country?

1. Spouses get relief on as much as $3 million in gain; non-spouse beneficiaries get relief on a maximum of $1.3 million.  Tax is due on amounts in excess of these.