The Death (And Resurrection) Of the Death Tax

Ding Dong the estate tax is dead! But don’t celebrate yet, Dorothy. This development is actually making things worse. Much worse.

In December, the U.S. House of Representatives voted to extend the then existing estate tax law indefinitely. This would mean that, if the Senate concurred and the President signed the bill into law, 2009’s estate tax rates – 45 percent for individual’s estates over $3.5 million and $7 million for married couples – would become permanent.

However, the Senate failed to act prior to the end of the year. As a result, the estate tax legislation that was passed during the early years of the Bush Administration continues in force. This is the law that over the years increased the size of a person’s estate that would not be subject to the estate tax from $600,000 to $3.5 million. By 2009, if your estate did not exceed $3.5 million, you would not pay any estate tax.

Also, pursuant to this law, the estate tax completely disappears in 2010, only to return with a vengeance in 2011. Next year the $3.5 million exemption level drops to $1 million, thereby exposing millions more of families to this taxation. The estate tax rate also increases from 45 percent to 55 percent.

This, due to the inaction by the Senate, is where we are today. No estate tax this year, a draconian confiscation of family assets in 2011. For a person dying in 2009 with an estate of $10 million, the estate tax would be $2.925 million. If he dies in 2010, there would be no tax. If he can hang on until 2011, Uncle Sam would claim $4.95 million dollars.


Also included in the Bush era legislation was a little provision that in 2010 ended the “step up in cost basis” for determining capital gains. For example, if years ago your grandfather purchased stock in the company that employed him for $2 per share and now the stock is worth $100 per share, and he sold the stock today, he would be liable for capital gains tax on the $98 gain for each share sold. If he was in the top tax bracket, that would be $14.70 for each share sold.

However, if prior to selling the stock, Grandpa died in 2009 and left his stock to you, your tax basis would be the value of the share at the date of his death – the “stepped-up” basis. If the value was $100 at the date of his death and you sold it for $100, there would be no increase in value from your stepped-up basis and thus no capital gains tax.

In 2010, according to the law, you would inherit Grandpa’s $2 cost basis along with the stock and be subject to the $14.70 capital gains tax when you sold the stock. As you can see, this, along with talk from the Obama administration about raising the capital gains tax rate, would be a direct assault on America’s middle class.

To be fair in my analysis, the law gives each taxpayer $1.3 million of step-up at death. This sounds like a lot, but when you start to look at the value of business assets and real estate a person has accumulated during her lifetime, it becomes apparent that this provision gives her family very little protection. It also imposes a massive record keeping burden over decades to track the step-up. A similar approach was tried in the mid 1970’s and almost immediately repealed.


By way of illustration, let’s look at the case of a single mother of two, who in the mid 1970’s started a modest retail business to help pay the bills. She bought a small shop out of which she operated the business and struggled for years to make the mortgage payments, both on her shop and her home. She finally reached a modest level of success in her business and upon her death in 2011, left it all to her two daughters.

The daughters had helped their mother in the business and wanted to continue its legacy. The value of the mother’s estate – which consisted mainly of the business building, the business assets and inventory and the family home, was $2 million. The business building had increased in value from $100,000 to $900,000 and the home from $100,000 to $500,000. The business itself had substantially increased in value and the rest of her estate comprised an IRA and some modest investments.

The daughters looked at their situation. The estate tax burden would be $550,000. There was not enough cash and liquid assets in the estate to pay it. The house would have to be sold if they wanted to continue the business. Assuming they could get full value, they would be subject to $60,000 in capital gains tax. The total tax would be $610,000 on a $2 million dollar estate.

As a result of the law, this middle class family could not continue to own and operate the family business that had become so much of their lives and had been the dream that their mother had fought and slaved to make a reality. Taxes would crush her legacy.

It was always assumed that Congress would extend the $3.5 million estate tax exemption or even permanently eliminate the estate tax. The Republican controlled Congress prior to 2008 apparently didn’t have the guts to do it and now, with Democrats controlling both Congress and the White House, and the massive government deficit, who knows what direction it will head.

What we know to be sure is, if this law remains as it is, it will devastate small family businesses, cripple the middle class and create more dependence on government. None of this is worth celebrating.

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