Estate Tax Whiplash!

Thanks to Senate gridlock, taxpayers who are trying to do effective estate tax planning are in for a case of estate tax whiplash over the next few months.  The federal estate tax is due to disappear for one year starting in about two weeks, however, it may reappear unexpectedly and retroactively.

When the Senate refused to act this week, it opened the door for the estate tax to disappear in two weeks, although nobody knows for how long.  Under current law, the estate tax disappears on January 1, 2010 for the whole year and then reappears on January 1, 2011 at the old 2001 rates.  Also, the gift tax maximum rate will fall to 35% and for some assets inherited in 2010, the step up in basis will disappear (with the step up in basis, the capital gains tax is based upon the difference in value between what you sell it for and what it was worth at the time of death.  With the new law, you use “carry over basis” which means you need to go back and find out what the heir originally paid for it and use that basis.  This could end up being an accounting mess).  All this happens because the 2001 tax act phased out the estate tax over a 10 year period, repealing it entirely in 2010.  But the estate tax returns in 2011 under 2001 rules – a $ 1 million exemption and a 55-percent top rate.

The House had passed a law a couple of weeks ago making the current top rate of 45% and exemption amount of $3.5 million permanent.  Senate republicans wanted the rate lowered to 35% and the exemption at $5 million.  But lacking any unity in the Senate, Democrats failed to even get the Senate to vote on the issue.

The whiplash mess is that we are not sure if Congress will get their act together in early 2010 and pass a new estate tax law and whether it will be retroactive to January 1, 2010.  Senate Finance Committee Chair Max Baucus (D-Montana) has promised to revive the issue next month and make it retroactive to January 1, 2010, but that may not happen. 

In the meantime, I would not be making any large gifts assuming the new law will be in place.  You will want to watch and see what happens and when the dust settles, make your plans then.