Estate Tax Changes for 2010 and 2011

With the coming of 2010 and subsequently 2011, major changes will occur with regard to the federal Estate Tax.  It gets a little complicated, so each year’s primary provisions are listed below to help you figure it out.

The conclusion is that next year, 2010, is the best year to die, from the estate tax perspective. The downside is that there is a limit on basis step-ups (more later) but you’re allowed to use capital losses and NOL carryovers to step-up basis.  You can see the details below:

2009

At death, assets in the estate receive an unlimited step-up in basis to the fair market value as of the date of death. This means that, if a piece of property owned by the decedent had a basis of $1,000 and the fair market value was $5,000, when inherited, the new owner has a piece of property with a basis of $5,000.  So when the new inheritant decides to sell the piece of property, capital gains tax will only be owed on any amount received above $5,000, or a capital loss allowed if the sale is for less than $5,000.  This step up in basis is unlimited.

Estate tax is assessed on the amount of any estate above $3.5 million, at a rate of 45%.  All of those assets mentioned above (in the step-up paragraph) plus all other assets not subject to step-up, totaled together will be taxed at a rate of 45% on any amount above $3.5 million.  So if the gross estate was $4 million, $500,000 would be taxed at 45%, for a total of $90,000 in estate tax.

All capital loss and NOL (net operating loss) carryovers are lost at death.  When you experience a capital loss due to the sale of an asset, you’re allowed to offset that against capital gains, and then you’re allowed a $3,000 write-off against your ordinary income each year.  Any amount of capital loss left over (after capital gains and the ordinary income write-off) is carried over to future years and treated the same way.  If any carryover still exists after your final income tax return, that carryover is lost.  The same applies to carried over net operating losses (NOL) from your business.

2010

Basis step-up upon death is limited to $1.3 million (plus $3 million for property passing to a surviving spouse).  The rules mentioned in the 2009 section apply here, but it is limited.  In addtion, estates can exclude gain of up to $250,000 from the sale of the decedent’s personal residence – this is not included in the $1.3 million limit on basis step-up.

Estate tax is repealed – there is a zero tax rate on any and all estates, of any size.  Using our example estate worth $5 million – the estate tax would be zero.

Capital loss and NOL carryovers can be included as part of the $1.3 million basis increase, rather than being completely lost as was the case in 2009.

2011

Same as in 2009, assets in the estate receive an unlimited step-up in basis to the fair market value as of the date of death.

Estate tax comes back, with a vengeance.  Any amount of an estate above $1 million is assessed by the estate tax, at a 55% rate.  So, our example estate of $5 million in gross value would have a tax of 55% on $4 million, for a total of $220,000 in tax.  Quite a difference there!  In 2009 there was a $90,000 estate tax; in 2010, $0 estate tax; and in 2011, the estate tax is $220,000.

Also, as before, capital loss and NOL carryovers are lost at death.

Conclusion

So, as I mentioned before, if you have a sizable estate and you’re planning to die, you should definitely do it in 2010.  Your family may argue with you, but believe me, when they see the size of the tax savings, they’ll get over it.  Of course I’m only kidding! Rarely does it actually make sense to plan life-altering events around the tax code – and this isn’t one of those cases.  But the federal government sure does make it compelling…

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Jim Blankenship, CFP®, EA, is an expert in personal retirement, IRAs, and tax issues, with more than 20 years of experience in the industry.  . Read more from this author