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Biggest Estate Tax Problem? Income Tax

The estate tax rules currently on the books are causing a great deal of consternation. Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the federal estate tax and the generation-skipping tax both have been repealed, but only for those who die in 2010. In 2011, both taxes are scheduled to be revived with less-favorable exemptions and a higher top tax rate.
Though it’s possible there will be some kind of legislative compromise on a permanent estate tax, that’s certainly not guaranteed. And one provision of the current law, in particular, could have a big impact on inheritors if it remains in place. The change to a “carryover basis” for inherited assets could result in substantial income tax liability even for beneficiaries who don’t face estate taxes.
Prior to 2010, those who inherited appreciated assets could benefit from a “step-up” in basis to the value on the date of death. For instance, if your grandfather bought stock many years ago for $100,000—the investment’s original cost basis—and it was worth $1 million when he died and left you the shares, your basis for the stock would be stepped up to $1 million. That was the amount you would use to calculate your capital gain or loss when you finally sold the shares, and it let you avoid tax on the $900,000 gain during your grandfather’s lifetime. And any potential estate tax on the transfer may well have been covered by your grandfather’s individual exemption—a generous $3.5 million in 2009.
Now, though, the tax landscape has changed dramatically. For 2010, at least, the step-up in basis has been replaced by a system requiring heirs to carry over the basis of inherited assets. Suddenly, you’re potentially liable for that $900,000 gain. In fact, it would be covered by a $1.3 million increase in basis that individual heirs are allowed, and a spouse who inherits appreciated assets can bump up the basis by $3 million. But income taxes on larger inheritances could be substantial under the new rules.
Rising tax rates for capital gains and income could also increase your costs. The maximum rate on long-term capital gains (on assets held more than a year) rises to 20% in 2011 from its current 15%, and the top personal income rate jumps from 35% to 39.6%. And a revenue-hungry Congress might boost rates still higher.
This looming income tax problem further complicates estate planning while laws are in flux. If you are expecting an inheritance or are planning your own estate, we can work with you and your attorney to develop strategies that may minimize your exposure, perhaps by increasing gifts between living donors and recipients. Please give us a call to set up an appointment.

This article was written by a professional financial journalist for Legend Financial Advisors, Inc. and is not intended as legal or investment advice.


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