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Thursday, Mar 28, 2024

Estate Tax Will Return as Big Issue in Next Few Years

By MICHAEL HACKMAN As the presidential race heats up, all is relatively quiet on the issue of repeal or elimination of the estate tax, an issue to which substantial Congressional attention and campaign contributions have been devoted over the last several years. Frequently asked questions include: Is the federal estate tax still going to be eliminated? The estate tax remains scheduled to be repealed effective for taxpayers who die in 2010. However, it is scheduled to return, with only a $1 million exemption, in 2011. What is the political outlook? Estate tax repeal is a genuine political football. Matters totally unrelated to the efficacy or the rationale behind the estate tax have had, and will continue to have, a significant effect on the political outlook. Certainly, some action would be expected after the 2008 elections. While in general Democrats are in favor of keeping the tax in some form, and Republicans against it, that remains a gross oversimplification. Many observers believe that the estate tax would have been repealed two years ago; however, Hurricane Katrina threw the federal budget into turmoil and made permanent repeal politically unfeasible. What is the estate tax exemption? The estate tax exemption is $2 million for taxpayers dying in 2006, 2007 and 2008. It will increase to $3.5 million in 2009, is scheduled to disappear in 2010 (when there is no estate tax) and come back in 2011 with a $1 million exemption. Is the gift tax exemption also $2 million? No. The gift tax exemption is fixed at $1 million, and will not increase (and will not be eliminated even if there is no estate tax). Is the gift tax annual exclusion still $10,000? In addition to the $1 million lifetime exemption, there is an annual exclusion, which was $10,000 for many years. However, the annual exclusion is indexed for inflation in $1,000 increments, so it had increased to $11,000 and is now $12,000. This means that a taxpayer, each year, can make $12,000 gifts to as many people (related or not) as he or she desires. A married couple can give twice that, so, for example, a married couple with two children and two grandchildren can give $96,000 (2 X $12,000 X 4) during a calendar year without reducing the $1 million exclusion. Is there a California estate or inheritance tax? Not any more. A portion of the federal estate tax (referred to as the “pick up tax”) went to the State of California, but the legislation which resulted in the estate tax repeal phased out the state pick up tax over four years, which has now been accomplished. As a result, the California budget does not benefit from any estate or inheritance tax. California has no gift tax. Is there an estate tax exemption for gifts of interests in family businesses? Again, not any more. An exemption for a portion of such gifts was phased out when the estate tax exemption reached $1.3 million. Are interests in family businesses treated favorably for estate tax purposes? Yes, under certain circumstances gifts of interests in closely held businesses may be eligible for significant tax deferral at low interest rates. What does a “step-up in basis” mean? As a general rule, at death the “basis” of an asset is stepped up, or down, to its fair market value at death. For example, if a taxpayer purchases raw land for $100,000, that becomes the taxpayer’s basis, so if he sells the land for $200,000, he is taxed on the sale price less his basis, or $100,000. If he holds the property at his death when it is worth $200,000, the basis in the hands of his heirs is stepped up to $200,000, so if they sell it for $200,000, they have no gain. As a general rule, when one spouse dies both halves of their community property are stepped up or down to fair market value. The step-up in basis is the hidden advantage of the estate tax, and the death of the first spouse generally results in tax advantages for the survivor. What will happen to basis if the estate tax is repealed? Assuming no change in the law, there still would be a step-up (or step-down) in basis at death, subject to limitations. On the death of a single person, his or her estate would be eligible for up to $1.3 million in increased basis. On the death of the first spouse in a married couple, the survivor would be entitled to an additional $3 million in increased basis (for a total in step-ups of $4.3 million). If legislation results in repeal becoming permanent, it is probable that the step-up issue will be revisited. While the legislative front is relatively quiet now, it is sure to heat up once a new president is elected and estate tax repeal in 2010 and the bizarre resumption of the tax in 2011 creeps ever closer. Estate plans need to have the flexibility to deal with whatever might happen in Washington. Michael Hackman is a shareholder at the Encino law firm of Lewitt, Hackman, Shapiro, Marshall and Harlan specializing in taxation, business and health care law.

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