Tax Legislation Update: Estate Taxes and Gift Taxes

Estate Taxes going Away? Never!
You may have heard that the Estate Tax or Inheritance Tax goes away in 2010. We have long said that this will never happen and that Congress will act and change this before the estate tax goes away in 2010. There are many reasons why it will never happen, but here are a couple.

Income Tax Short Fall; Budget Deficit
First, the United States Government can absolutely not afford to eliminate the estate tax right now given the huge income tax short fall and corresponding Federal and state budget deficits that we are facing today. So, Congress must act now and eliminate the sunset provision for the estate tax before it goes away in 2010.

Step-up In Cost Basis
Second, if the estate tax were to go away, so would the "step-up" in cost basis on property that was inherited. Taxpayers would actually owe more in taxes if this happens. The concept of a step-up in cost basis can be confusing, so let me try to explain it.

Let's assume that your parents bought property years ago for $100,000.00. The same property is worth $1,000,000 today. It has a capital gain of $900,000.00. Your parents now die. The value of this property ($1,000,000.00) is included in the total value of their estate for estate tax (inheritance tax) purposes, which means that the value is used to calculate any estate taxes that their estate would owe.

You then inherit the property. The question is what is YOUR cost basis in the property now that you have inherited it? Your cost basis is stepped up to the value of the property at the date of death or $1,000,000.00 because that value was included in their estate and used to compute any estate tax. It has already been taxed through your parents estate, so you cost basis starts all over. You could sell the property for $1,000,000.00 the next day and pay absolutely no capital gain taxes.

The Buzz On Capitol Hill
So, now you have the background and why we think the estate tax will not go away in 2010. So, let's back this position up with the buzz on the street.

Senator Max Baucus (D-MT), who is the top tax policy maker on the hill, has introduced legislation that gives us a good idea at where Congress is headed. It will most definitely change in some form before it is ultimately passed by both the Senate and the House of Representatives, but it does provide some insight for those taxpayers that must start planning now.

Basic Estate Taxes and Gift Taxes (As Proposed)
Senator Max Baucus wants some significant changes to the estate tax and gift tax codes. The basic estate tax and gift tax exemption would be fixed at $3,500,000.00 beginning in 2010, and then would be indexed to inflation and adjusted accordingly after that. The gift tax exemption is currently at $1,000,000.00, so this is a hefty increase if it gets bumped to $3,500,000.00. You could gift up to $3,500,000.00 without paying a gift tax.

The estate tax rate would be capped at 45%. This is the current rate, so no change there. This way the estate tax and gift tax exemptions would be tied together again at $3,500,000.00.

There would also be some easing for married couples. The amount of unused exemption could be carried over to the surviving spouse and used upon their death. These changes mill simplify many areas within estate, gift and charitable planning.

We will now have to sit back and wait to see what the final legislative action looks like.