Can the IRS Roll Back Time on the Estate Tax?

2010 is the year of no estate taxes.  Once upon a time, before the 2001 Bush tax cut, every heir had to pay estate taxes if they inherited more than $1 Million.  Now if someone died in 2010, their beneficiaries will have no federal estate taxes.   This was not intended.  Congress had meant to rescind the waiver of estate taxes in 2010 but the politicians were too busy fighting about other things to get it done.

In October 2009, Jeffry Picower, the man who made $7 billion in the Bernie Madoff Ponzi scheme, was found dead in his Palm Beach, Fla., swimming pool.   (Some investigators considered Picower to have been the actual mastermind of Madoff’s massive con, or at least an equal “partner in crime.”)   Let’s say that his daughter got $5 billion from him.  For simplicity’s sake, the calculation would be 45% of $5 billion = $2.250 Billion.

IRS building by Keithius

In March of this year, 2010, David Duncan, a Houston billionaire who ranked 74th on a list of the world’s richest people died.   Duncan was Chairman of the Board for Enterprise Products Partners, a company he started in 1968.  In 2010, he ranked in the top 100 of Forbe’s Richest.  If he had died 3 months earlier, his $9 billion estate could have meant a federal estate tax bill of up to $4 billion.  And, under the law as it is today, it could be up to almost $5 billion if he died 10 months later in 2011.

This seems great for taxpayers who inherited in 2010 doesn’t it?  BUT WAIT.  It’s not that simple.  Uncle Sam is our silent partner and he never ever forgets to collect.

Wake me up when the IRS stuff is over
  • The government needs more money to spend. Congress is trying to cobble together something to make the estate tax retroactive.  They want to move the clock back and say “Yep, you died but we still want our money and this is what the law is now.”   There are billions of dollars that they can collect.

Is it constitutional?  That’s for a constitutional lawyer to answer.   Congress cannot make new laws that go back in time to collect taxes but they can amend the existing tax law to do so.

If something gets enacted this year to affect the federal estate taxes, it may go all the way up to the Supreme Court in a fight and put every single estate in limbo until the fight is resolved.  An heir won’t know what the rules are until the IRS and the government tells them it’s so.   You could be sitting on money for years waiting for a resolution.

  • Cost basis - two simple words but it means billions in extra taxes.   Cost basis is accounting speak for how the IRS calculates your estate value.  The IRS has different cost basis for 2009 versus 2010.

1.  It can be as simple as what you paid for something.  i.e.  You bought a house in 1972 for $38,000.  Your cost basis is $38,000 plus whatever you spent to upgrade the house such as adding in a second story.  (2010)

2.  “Step-up” cost basis – This was the rule in 2009.  Heirs were allowed to set the cost basis as the current value of the asset.   This means that the same house bought in 1972 for $38,000 now have a “step-up” basis of $3 Million because that is the value the house is worth at death.

Keep in mind, you can also choose the date of valuation as either date of death or six months after the date of death.  There’s limitations on how you can use the six month rule.

3. Now think hard if you own a business.  Think of all the paperwork that you would need to document in order for your children to establish a cost basis.   Do you know what they all are and do you think that you kept track of it?

4.  People who invested in their employer’s companies – ESPP (Employee Stock Purchase Plan) – Did you keep track of all your itty bitty trade each time and all the stock splits?   I’m still trying to find all my paperwork going back 25 years with purchases of $20 at a time.

  • No estate taxes BUT hello capital gains taxes. – That’s right, step right up folks and do si do.  Let’s spin you around and match you up with Uncle Sam’s clone.  You now will be taxed even if you’re not a millionaire.

1.  In 2009, you get to set your cost basis as the value on date of death (or six months later if qualified).  This means that you pay estate taxes but you don’t have to pay capital gains taxes if you sell the assets at the same value as the date of death.   Your $38,000 house is now worth $4 Million.  Your cost basis is now $4 Million.

2.  In 2010, the IRS has what is called a modified carryover basis.  The details are complex but the essence is that heirs have no estate taxes but the cost basis has been adjusted to the actual cost for inheritance purposes.  This means that heirs now have to pay capital gains taxes on how much the estate has increased in value since assets were bought.

Your $38,000 house is now worth $4 Million.  Your cost basis is $38,000.   Your heirs do not pay estate taxes but they now have to pay capital gains taxes when they sell the house.   2010 long term capital gains tax is 15%.   Taxes is now owed on the different between $38,000 and $4 Million = $3,962,000.

It gets more complicated.  There are options to adjust your cost basis up but you should consult your tax advisor.  There is t

oo much details to go into here.

As you can see, it actually costs people more to not have estate taxes in some situation.

The takeaway from this for the average middle class family is that in 2010 you will have a shadow federal estate tax in the form of capital gains.    For example, your entire inheritance may only be a $200,000 mutual funds but your parent bought the mutual fund at $25,000 years ago.   Your cost basis for 2010 and in the future is $175,000.  When you sell this mutual fund in 2010, you will have capital gains tax of $26,250.  If you sell it in 2011, you will have higher taxes.


The changes in the estate taxes for 2010 has a ripple effect on everyone regardless of whether they are millionaires or not.   No one knows if or when Congress will make any changes to the law.   This has caused tremendous uncertainties for everyone from accountants to planners.  Your advisers have to be on top of their game.   Here are some things that you need to do to protect yourself from risks.

  • Review your existing trust documents. Make sure that your trust has the correct wording and calculations to address the changes for 2010.  Is there any wording that can raise your tax bill.
  • Have your parents review their trust documents. Most people don’t do any reviews of their trust and your parents may have a trust that has not been updated since the 1980s.  Laws have changed tremendously since then.
  • Set a deadline for December 2010 to review and update your trust documents again in 2011.  Have it ready to go first thing on January 1, 2011.   Estate tax law reverts back to pre 2001 laws at that time.
  • Don’t spend all the money. Leave at least 50% preferably liquid for any anticipated taxes.  Better safe than sorry.
  • Make sure you have good advisers who knows what they’re doing. Tax laws are complicated and detailed.  You need advisers who are staying up to date on things.  It’s very easy to lose hundreds of thousands of dollars in taxes due to an accident of paperwork or interpretation.
  • If there is divorce in your family or you have a standard marital trust – review the wording on your trust.  This is critical and can change the intent of your wishes.  The formula clauses for marital trusts to preserve the spousal exemption can be negatively interpreted.  You could disinherit someone by accident or cause additional taxes.
  • Factor in state estate taxes when reviewing trusts. Some states attached their estate tax laws to the federal laws and are in a scramble to fix or adjust their rates.  This can also cause hundreds of thousands of dollars in extra taxes if not planned for.
  • Don’t wait just because you’re only 30 years old. It doesn’t matter what age you are at.  If you have family and assets that needs a trust, just do it.  Age is no guarantee that you may die tomorrow.   Take the steps to protect your family.

Just because the estate tax was abolished for 2010 does not mean that taxes on inheritance disappeared.   In fact, more people are going to owe taxes because of this situation than if an estate tax is still in place.   There will be many mistakes and people being disinherited by accident because someone did not make the effort to update their trusts or planning.  Chances are that taxes will actually be higher in 2010 for some situations.  Many low income and middle class family who would not have been subject to taxes under the estate laws now will owe taxes for capital gains.

If you care for your family, make the effort to review your planning and paperwork.  Do your research.  Would you want to leave a spouse without any income or assets?

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photo credit: chumpysclipart

photo credit: Keithius

Disclaimer:  The information contained herein is not warranted to be accurate, complete or timely.   Money and Risk obtained information from but there are details that space and time do not permit inclusion.  Money and Risk and its content providers are not responsible for any damages or losses arising from any use of this information.  The reader is reminded that you are responsible for doing additional research, consulting with your professional advisers and to always question any information as part of your due diligence.

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