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What’s Really Going on With the Estate Tax?

No Federal Estate Taxes in 2010…Maybe

On January 1, 2010, the federal estate tax officially went away. Although there were a few proposed bills in the house to keep the estate tax at 2009 levels (45% tax rates on assets over $3.5 million), these bills did not pass in time. In 2011 estates over $1 million will be taxed.

That said—look out! There’s talk of bringing the federal estate tax back retroactively this year! While there may be constitutional issues with a retroactive tax, it wouldn’t be the first time a retroactive tax law went into effect and some estate planners think the IRS wouldn’t mind arguing this one in court. At The Estate Planning & Asset Protection Law Center of Dennis Sullivan and Associates, we are helping our clients plan for both cases, whether a Federal Estate Tax is in effect this year or not.  In either case, we still need to plan for the Massachusetts Estate Tax.

Estate Planning Family

What taxes are there in 2010?

Even if there is no retroactive federal estate tax in 2010, there are important issues for families to consider.

First, you may be aware that Massachusetts has its own estate tax! In 2003, when federal exemption amounts started to rise, Massachusetts was one of the states that chose to decouple, which is to create its own separate estate tax, on estates over $1 million. That means that if you have more than $1 million (including the value of assets you might not have thought about, like life insurance and annuities), your estate will be subject to tax!

Second, the federal gift tax is still in full force—if you give away more than $1 million during your lifetime, you will be taxed at the rate of 35%!

Third, is one you may not have thought of—capital gains! Under the old rules, heirs took a step-up in basis, so that if you sold inherited stock, real estate or other property, you only had to pay capital gains taxes on post death appreciation. In 2010, that’s no longer true. Capital gains step ups are limited to $1.3 million—any property above that will cost your heirs 15% in capital gains taxes when it is sold.

This is a tax to watch out for, since under the new rules, the capital gains tax will effect many families who would have paid no federal estate or capital gains taxes at all under the 2009 rules! And if you don’t have records for the basis of each property—that is the price it was originally purchased for, this can cause your family an accounting nightmare.

What should you watch out for if your estate plan was done before 2003?

We find that most trusts we review that were put together before 2003 will have what is called a ‘formula funding clause’ based on old law. If these clauses have not been updated they can have some extremely negative consequences under current law, including:

  • Disinheriting a spouse (Most if not all of our clients are interested in protecting their spouse, not only from taxes, but the increasing cost of nursing homes)
  • Causing tens of thousands of dollars in completely avoidable Massachusetts Estate Tax—on the first death!

What happens in 2011?

If Congress continues to do nothing, the estate and generation skipping tax apply to tax amounts over $1 million! And the tax that’s coming back is the one last seen in 2001—estates over $1 million dollars will be taxed at the rate of 55%!

No one knows what will happen for certain, the only thing we’re sure of is that the federal government needs money and it will have to come from somewhere!