Will You Be Impacted by the Death Tax?

Ha! I chose that title because I know it will rile some people up that I called the "estate tax" the "death tax." That's just the sort of mood I'm in today.

Bankrate lists the estate tax exemption levels as well as the maximum tax rate on the estate for various years as follows:

• 2008 -- Estate tax exemption: $2 million; Maximum rate on estate greater than exemption: 45 percent
• 2009 -- Estate tax exemption: $3.5 million; Maximum rate on estate greater than exemption: 45 percent
• 2010 -- Estate tax exemption: Tax repealed; Maximum rate on estate greater than exemption: Tax repealed
• 2011 -- Estate tax exemption: $1 million; Maximum rate on estate greater than exemption: 55 percent

A few thoughts on these:

1. We're right now in the middle of having our will updated and this is an issue for us. I'll be updating you later on the process once we're through with it.

2. Don't forget the impact of life insurance. If you have a net worth of $1.2 million and life insurance of $1.5 million, you're $700k over the $2 million limit for 2008.

3. Husband and wife can pass as many assets to each other upon death as they want. But when the second one dies, then the estate tax is due.

4. I'm sure there's some rule around it, but couldn't people pass along assets forever (through marriage) and avoid estate taxes? For example: A marries B. A dies and passes all assets to B. B marries C. B dies and passes all assets to C. C marries D. C dies and passes all assets to D. See how this could go on forever?

5. For those of you who've been in a cave the past year, we're in a presidential election year. And the first thing whoever gets elected is going to do is change taxes (including the estate tax.) So these numbers could go up or down depending on who gets elected and so on (though the numbers for 2008 are solid -- they won't be able to change those, and I don't see Bush/Congress changing anything in 2008.)

6. Now you see why people joke that rich, elderly people are trying to hold on until 2010. I'm sure there will be some sort of story/litigation about a wealthy person who's kept alive until January 1, 2010 or prematurely allowed to "expire" before December 31, 2010 because of the repeal above (that is, if it's kept in place.)

7. Tons of people are going to have a rude awakening if the tax exemption goes down to $1 million again.

Comments

[frugal couple]

For us, you bet we will be hit by the Death Tax. We are a hard working, thrifty couple who will get slammed by this tax. We are the personification of everything that is written in this blog – we save (pay ourselves first); abstain from excess consumption, give to charity and invest for our future years together. Your statement: “Husband and wife can pass as many assets to each other upon death as they want.” does not apply to us because we can not get married. We are gay. So don’t complain out there till your walk in our shoes

[anon]

I have never understood the justification for the estate tax.

But that said, what's up with the 2010 to 2011 changes. They repeal it then make it the most invasive it's been? Huh?

[Kevin]

Anon - it's called a sunset provision. That's how Congress can create tax cuts now and pay for them later. Very clever, huh?

FMF - Re: #4, you are correct, in fact I did a estate tax return just this year for a wealthy man that was married, his first wife died (and left him most of the assets, although she did have a significant amount in trust), remarried and his new wife received everything (minus what went into another trust) tax-free this time around. If she remarries, she can pass that along tax-free to her new spouse.

Frugal Couple - that is a shame. I guess your best bet is to get a good lawyer or hope the estate tax is abolished by the time you have to worry about it.

[Tony]

The 2011 exemption amount is simply a reversion to the 2002-2003 unified credit against federal estate tax. The estate tax laws are likely to be revised before 2010-2011, such that the exclusion amount for 2011 is adjusted in line with the 2007, 2008, etc. upward exclusion adjustments.

The hypothetical you posed regarding simply forever avoiding estate tax vis a vis the marital exclusion is a potential loophole closed by Congress under the Internal Revenue Code and its regulations. A real basic explanation: once property has already been excluded by the marital deduction, the exclusion cannot be taken a second time.

[K]

Dude, if I had net worth of 1.2 million, I wouldn't be reading blogs like this one.

[Rolltimer]

Re: "2. Don't forget the impact of life insurance. If you have a net worth of $1.2 million and life insurance of $1.5 million, you're $700k over the $2 million limit for 2008."

My understanding is that insurance proceeds pass to the beneficiary untaxed unless you happen to make your estate the beneficiary.

[planner]

I'm surprised you didn't call it the "Can't Take It With You Tax" after your cartoon the other day.

Congratulations on being at that level already. I'm sure since you get the financial help you need your CPA and others will have you prepared. I'm looking forward to the update after your plans are together.

[Foobarista]

I have two problems with how estates are handled in the US. My take is that death shouldn't be a taxable event, but it shouldn't reset basis values and such things, which it currently does. For example, if you own an apartment building, depreciate it completely - and take the usual depreciation writeoffs - and sell it, you have to pay capital gains taxes on the sale with a $0 cost basis (unless you do a 1031 exchange, in which case your $0 depreciation helps to set the basis for your new property). If you die and your heirs inherit it, your heirs can reset the basis to market value.

If inheritance tax is abolished, you and your heirs get to depreciate the apartment building twice without paying tax. So, my preference is for inheritance tax to be abolished, but basis should pass through to your heirs and not be reset.

[FMF]

Can anyone verify the insurance question above? It IS counted as part of the estate, isn't it?

[FMF]

Answered my own question. Found this article:

http://www.smartmoney.com/estate/index.cfm?story=check

Where it starts:

"MOST PEOPLE DON'T realize it, but unless you plan carefully, there's a good chance the government will end up as a major beneficiary of your life insurance policy. While it is true that life insurance death benefits are paid income-tax-free to the beneficiary, the proceeds are generally counted as an asset of your estate for estate tax purposes."

[Evan]

FMF you had to know I would chime in!

Insurance passes income tax free - which is what is meant when unknowing insurance salesmen (not all just the ones who don't bother to learn the laws surrounding what the sell) say you get insurance tax free.

Insurance found in the estate, i.e. insurance where the beneficiary is chosen and can be changed at any time is part of the taxable estate - and taxed at the aforementioned rates. 99% of the time this is the case – and the planners I work with make a lot of money fixing this one error and saving my/their clients - hundreds of thousands, if not millions, of dollars. If you want more info look up IRC 2036 or IRC 2038 – it has to do with “control” and power of appointment.

What most DECENT planners do (planner does NOT have to be an attorney, they can be an insurance salesman with experience or the drive to learn the business) - is set up an Irrevocable Life Insurance Trust (ILIT) which owns the insurance policy. This way it is found outside the estate.

Pros - Not part of your estate;
Cons - can't change the beneficiary without REALLY ADVANCE ESTATE/INSURANCE WORK (decanter statutes or my fav is selling the policy to another trust)

Disclaimer - Rec'd my law degree, passed the NY Bar and now am Director of Financial Planning for a Wealth Management Firm based on Long Island

[Lord]

Yes, the Irrevocable Insurance Trust exists for this purpose.

Don't forget about inheritance taxes. They frequently dwarf estate taxes in the states that have them.

Leaving estates undermines the motivation of heirs and devalues it in their eyes. Do them and yourself a favor and spend it.

[Meg]

The estate tax is a very important issue for me, and I will certainly be affected by it when my grandparents pass and then again when my parents do. People always like to talk about how "the rich" shouldn't complain, and I am very dismayed to see Warren Buffet and others with hundreds of millions or more come out in favor of the estate tax. But the truth is that Buffet has steadfastedly chosen not to give ANY money to his family members at all - and he's got BILLIONS. He has a skewed perspective.

Most people affected by the death tax are normal, hard-working Americans who saved and/or made their own fortunes. Few millionaires in America are spendy fat cats who inherited their wealth, though that's the image the liberal media likes to portray. The exclusion isn't $5MM or $10MM - it's historically been $1MM. The graduated tax break we've been getting over the last few years ("the govn will only take 45% of your assets if you die THIS year, ma!") is one of "George W's tax breaks for the rich" that's set to expire in 2010. And if a Democrat is elected this year there's basically NO chance of that tax break (or any of the others) being continued.

One million dollars is not that hard to accumulate over a lifetime, especially between a married couple. One average home and a decent retirement account, and you're there. Why should those people have OVER HALF of their assets beyond that taken by the government? In many cases family businesses or farms or homes must be sold to pay the tax - it's not as if most people have half their net worth sitting in liquid assets so they can write a check to the IRS.

[Kevin]

Meg - a little planning by a good estate tax lawyer or CPA and you can avoid most estate tax issues, unless their estates are over $4 million each couple.

[MonkeyMonk]

Meg -- I second what what Kevin said. If these issues trouble you so much you should seek out the advice of a good estate planner or estate lawyer. For the average American (as you state) it's really quite easy to avoid a much larger chunk of taxes above and beyond the upcoming 1 million limit (I should add that virtually nobody I've talked to think it will go back to the 1 million -- most think it will be reduced to 2 million and then pegged to some infaltionary number). If your grandparents are sitting on a giant nest egg they should already be looking into setting up various trusts in addition to taking full advantage of gift exemptions while alive.

I'm not sure how expensive property should best be handled.