The Estate Tax Is Dead (Maybe)

The estate tax will be fully repealed by 2010 but may come back in 2011.

The federal estate tax, a tax imposed on the assets left by the nation's wealthiest residents, is being phased out and is set to be fully repealed in 2010. However, in 2011, the estate tax will come back unless Congress votes to extend the repeal. In the meantime, estate tax rates will go down and exemptions will go up.

What's Next for the Estate Tax

Currently, the estate tax affects only people who die leaving a taxable estate of more than $2 million. The estate tax threshold will continue to rise until 2010, when the tax will be repealed. The exact dates and amounts of the changes are shown below.

YearEstate tax exemptionGift tax exemptionHighest estate and gift tax rate
2006$2 million$1 million46%
2007$2 million$1 million45%
2008$2 million$1 million45%
2009$3.5 million$1 million45%
2010Estate tax repealed$1 milliontop individual income tax rate (gift tax only)

If you're married, estate tax is most likely to be an issue when the second spouse dies. (When the first spouse dies, everything left to the survivor passes tax-free.) But if the second spouse owns all of the couple's property, and it's worth more than the estate tax exemption, estate tax will be due. So if you and your spouse together own more than $2 million (the current estate tax exemption), you may still want to think about using a tax-saving AB trust, making gifts of money or property during your lifetime, or using another tax-avoidance strategy.

Other Tax Changes That Affect Estate Planning

Other tax rules are changing, too.

Gift tax.Congress did not repeal the federal gift tax, although it raised the lifetime exemption and lowered the maximum tax rate. The lifetime gift tax exemption has gone up to $1 million and will stay there (unlike the estate tax exemption). That means you will be able to make a total of $1 million of taxable gifts over your lifetime before owing any federal gift tax. In addition, you can make an unlimited number of $12,000 gifts (to different recipients) of cash or other property each calendar year, completely tax-free. (These gifts do not count toward your lifetime exemption.)

Generation-skipping tax. This is an extra federal tax on transfers made from older folks to someone in their grandchildren's generation. When the estate tax is repealed in 2010, the generation-skipping tax will also disappear. Until 2010, the exemption amount will be the same as the estate tax exemption amount (shown in the table above).

Basis of inherited property. A change with far more widespread implications is the end of the "stepped-up basis" rule for inherited property. Under current law, when you inherit something, your tax basis (which is used to calculate your taxable profit when you sell something) is the market value of the property on the date of the former owner's death. So if the property's value has gone up significantly since the former owner acquired it, the basis is "stepped-up" to the date-of-death value. That means you get a big tax break when you sell, because your taxable profit is based on the date-of-death value, not the lower basis of the former owner.

That rule will end when the estate tax does, in 2010. From then on, when you inherit property, you can choose to take a stepped-up basis for only $1.3 million of it. If you inherit more than that, for the rest of the property, your basis will be the former owner’s basis or the date-of-death market value, whichever is smaller. You’ll have to choose which of the assets get the stepped-up basis.

For More Information

For more information, see Nolo's Estate Tax Resource Center or Nolo's book Plan Your Estate, by attorneys Denis Clifford and Cora Jordan. To make an AB trust, see Make Your Own Living Trust, by attorney Denis Clifford, or Quicken Willmaker Plus.