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Financial

Death Taxes Disappear in 2010: Is Your Estate Really Tax Free If You Die This Year?

by Robin S. Davis, CFP

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Death Taxes Disappear in 2010: Is Your Estate Really Tax Free If You Die This Year? The answer to this question is an absolute "maybe, maybe not".  The size of your estate, type of assets it consists of, and the state you live in will determine whether or not your heirs will pay any taxes.  The thing you have to remember is there is more than one kind of tax that comes into play when someone passes their estate to their beneficiaries upon their death.  These taxes include federal estate taxes, state inheritance taxes, capital gains taxes and income taxes.  

State inheritance taxes are different depending on which state you reside in.  Income taxes are generally paid on assets such as retirement plans and tax-deferred annuities.  The federal estate tax, or commonly referred to as the death tax, refers to the tax that can be a big liability to big estates, that prior to 2010 was any estate valued over 3.5 million dollars.  This tax has been repealed for 2010 which means you can leave any size estate 100% free from federal estate taxes which were as high as 45% in recent years.  This tax is scheduled to reset at estates over 1 million dollars with a maximum tax of 55% in 2011.

That's all well and good, if you die in 2010, but what some people may not be aware of is the capital gains tax treatment on an estate is also changing.  Prior to 2010, any appreciated asset such as real estate or stocks, would enjoy a stepped-up cost basis equal to the value at the date of death of the deceased.  That means if the beneficiary received a house or stock portfolio valued on that day of $2,000,000, and sold it for $2,000,000, there would be no capital gains tax due.  In 2010, only $1.3 million can be stepped-up ($4.3 million for spouses) and the rest of the assets would be subject to capital gains tax.  In the example above, $700,000 would be taxable.  This liability will increase if the beneficiary hangs on to it and it continues to grow in value.  Depending on the assets, some heirs may find they will pay more in capital gains taxes in 2010 than if the original federal estate tax laws remained in place.  Another issue is if there are several children or other beneficiaries.  The executor of the estate will have to determine how to split up the $1.3 million exemption amount among them, which will require the need for good and accurate accounting and bookkeeping.  

There is one wrench that can be thrown into the mix that could disqualify the exempted amount, such as when assets are left in trust to a spouse as opposed to an outright gift.  Some trust language could significantly alter or negate the exemption.  

It is important to make sure you and your financial advisors keep accurate records of all your cost basis information.  It is equally important to make sure you have your estate planning documents reviewed as soon as possible to make sure they are updated to incorporate the new law.   There are other creative tax planning and estate planning strategies that can be used such as charitable remainder trusts that allow you to defer taxes, receive current income tax deductions, and allow you to fulfill your charitable wishes.  

For those of you with more advanced estate planning, you should note that the generation-skipping transfer tax is also being repealed for 2010.  This means you may give gifts of any amount directly to grandchildren, for example, on a federally tax-free basis.

As stated above, the federal estate tax exemption is set to revert back to the old exemption of 1 million dollars in 2011 unless the law is changed sometime in 2010.  These two years of confusing change will create a lot of work for estate planning attorneys around the country and increased fees to their clients, but remember the old saying, don't bite off your nose to spite your face.  The expense of changing your will and trust planning today may very well be much less than leaving your beneficiaries with a huge tax bill later.  

Robin S. Davis is a Certified Financial Planner™, a member of the Financial Planning Association, and is the owner of Davis Wealth Management Group, Inc., in Stuart, Florida. She has been advising retirees since 1984 and has held over 500 public seminars on financial issues. She is the author of the book Who's Sitting On Your Nest Egg? Why You Need a Financial Advisor and Ten Easy Tests for Finding the Best One. Davis expresses the importance of utilizing a competent financial advisor. For more information, please call (800) 896-5422 or (772) 463-4441, visit www.daviswealth.com, or email: rdavis@daviswealth.com.

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