Rather than resolve the estate tax issue for good, to help people plan for the future, the compromise proposal sets rules only until the next election. The proposal eliminates estate taxes for individuals with less than $5 million, and for couples with estates below $10 million. The legislation also cuts the inheritance tax rate to a maximum of 35%.
There were a few surprises that will need to be sorted out if the legislation passes. For one thing, the new law doesn't seem to require the use of marital and family trusts (sometimes referred to as "A" and "B" trusts) in order to evenly divide the assets between a husband and wife. The proposal calls for the remaining spouse to be able to use the "unused portion of the estate tax exclusion," eliminating the need for an even division in how assets are titled.
The increase in the exemption amount to $10 million also surpised me. It significantly reduces the number of estates that will be subject to the tax, and reduces the tax burden for the taxable portion. Reducing the number of taxable estates will decrease the use of joint and survivor insurance policies sold for estate planning purposes, though local estate planning attorney, Dave Turner, points out that insurance remains a convenient planning tool for those estates in need of liquidity to pay estate taxes and for other traditional uses.
The proposal also gives heirs of estates created by a death in 2010 a choice between adopting the new rules and going by the old 2010 rules. While the 2010 rules eliminate a specific estate tax, heirs would still be required to pay capital gains tax on appreciated asset values if the gain exceeds a $1.3 million exemption amount. In instances where determining the cost basis is difficult, heirs may choose to adopt the new step-up rules even for family members that died in 2010.
Another surprise was that the proposal increases the amount that can be set aside to skip a generation without being subject to tax. In recent years, the generation skip gifting has been limited to $1 million, even as the estate exemption gradually increased to $3.5 million in 2009. The current proposal re-establishes a link between the individual estate exemption and the generation skip exemption, raising both to $5 million.
Whether or not this passes in its current form is anybody's guess, but we finally have a concrete proposal to consider and the proposal, being tied to the extension of the Bush tax cuts and the extension of unemployment benefits, has momentum.
Douglas B. May, CFA, is President of May-Investments, LLC and author of Investment Heresies .
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