The recent high profile passing of New York Yankees owner George Steinbrenner brought attention back to a topic which has seemingly been brushed under the rug for quite a while. Tax legislation known as the Bush tax cuts, which became law in 2001, gradually reduced the impact of the estate tax on the passing of large inheritances by raising the amount of the estate which was exempt from the tax year by year. For the estates of those passing away in 2010, the estate tax was eliminated – saving the Steinbrenner family an estimated $1 billion in taxes.
However, to gain passage in Congress, the Bush tax cut bill was negotiated to expire at the end of 2010, and both income tax and estate tax rates will roll back to the same levels before the tax cuts took effect. For estates, the rate would be 55 percent with an exemption of $1 million. Between now and the end of the year, we should see Congress act to define the level of both income tax and, hopefully, the estate tax for the foreseeable future.
Some preliminary discussions and bill proposals seem to be defining at least the range of what we might expect for the estate tax issue. While the estate tax impacts a minority portion of the population in terms of numbers, it is certainly an important issue for the families who are receiving inheritances, and if the law is allowed to roll-back to the old levels, it would certainly impact a much higher percentage of the population as wealth is passed from one generation to the next.
Senators Blanch Lincoln (Ark.) and Jon Kyl (Ariz.) have submitted a proposal to set the estate tax permanently at 35 percent with an exemption of $5 million. This means that the first $5 million inherited would not be taxed at all. Of course, there is an unlimited spousal exemption, which means that money inherited by a decedent’s spouse is not taxed, no matter what the amount is.
Last year, a bill in the House of Representatives was passed which set the estate tax rate at 45 percent with an exemption of $3.5 million. Both of the proposals on the table are more favorable to families than allowing the rates to roll-back to the pre-2001 levels, and it is widely expected that the final law will settle somewhere in the range of the proposals currently on Capitol Hill. Of course predicting the actions of Congress is tricky business and perhaps hard than predicting the direction of the stock market!
Those with estates larger than $3 million should consider some advance planning for the benefit of your heirs. Establishing revocable and irrevocable trusts may minimize the level of tax due on your estate. If you are in reasonably good health, purchasing life insurance to pay estate tax might be worthy of consideration. This strategy is especially important for those who will leave family businesses or valuable illiquid assets to their heirs. Unfortunately, the IRS is not very understanding when it comes to paying estate tax and there have been many cases of families forced to liquidate businesses or sell assets (like professional sports teams) which have a large value but are hard to sell for their true worth, especially when buyers know you have to sell.
Although it won’t solve major estate tax issues, gifting of assets to your heirs while you are still alive is also a good strategy to move value out of your estate and reduce the tax man’s bite. The limitation of gifts is currently $13,000, and applies to the value of a gift from one person to another. So, a husband and wife can give a total of $26,000 annually to each of their children, grandchildren or any person they choose. Gifts in excess of the limit can be taxed by the IRS, but there does not seem to be a lot of policing of gifts. Still, if you are audited, the IRS could find a paper trail for gifts in excess of the limit.
We should know more about the details of both the estate tax situation and the income tax situation over the next few months.
Tom Breiter is president of Breiter Capital Management, Inc., an Anna Maria based investment advisor. He can be reached at 778-1900. Some of the investment concepts highlighted in this column may carry the risk of loss of principal, and investors should determine appropriateness for their personal situation before investing. Visit www.breitercapital.com.