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The State of the Estate Tax

Even though I am not a baseball fan, I know who George Steinbrenner was, as he was someone a bit larger than life. As you might have guessed from the title, this post is not an homage to Mr. Steinbrenner, but a discussion of the current estate tax rules.

There was a time (seems like yesterday) when the estate tax exclusion was one million dollars, but that was back in 2002 and 2003, and the number was even lower in years prior. But along with the rising exemption came one strange anomaly in the code, a year with an unlimited exemption, no tax on the estate of anyone fortunate enough to die this year. This doesn’t mean his heirs get away with no taxes ever due. Along with the estate tax, the rule allowing a stepped up basis went away as well.

I know, this is a bit technical, so let me take a step back. To keep the numbers simple, if one died in 2002, and left, say $4,000,000 to his non-spouse heirs, the first $1M is tax free, and then the remaining $3M is subject to an increasing scale up to a 50% rate. So the heir would collect about $2.7M and their basis would be the value at the time of the decedent’s passing (or 6 months later whichever is higher). Under these rules, the decedent’s cost makes no difference. The $4M could have been stock purchased for  $10,000 (Don’t we all wish?) or cash from having sold something else and just paid the taxes.

With the 2010 rules, however, the estate gets only a $1.3M step up. So in our example, it makes a big difference whether that $4M is cash or if it’s stock that cost the decedent $10,000. Old rules allowed an unlimited spousal inheritance, new rules give Mrs. Steinbrenner an additional $3M step up. If the number I read are accurate, the Yankees were bought for $10M and the estate is worth $1.1B.

If the family sells their stake, capital gain taxes are due at the prevailing rates, this year, 15%, but expected to rise in 2011. Eventually, Uncle Sam will see some of his money.

So far, I’ve made no judgment, just offered some facts. I don’t know if there’s any structure that will be agreeable to all. There are those who feel the money has already been taxed along the way and the estate tax is a form of “double taxation.” Other feel that there’s too much money concentrated among too few people and somehow the estate tax will help to “level the field.” Objectively speaking, if that’s possible, I think the current rules help avoid the former concern as only gains not already taxed will be taxed eventually and only when the assets are sold. The risk that the “family farm” will have to be sold to pay taxes  when gramps dies is gone.

Personally, I can live with whatever structure there is, my only objection is these erratic changes over the years. You see, each set of rules requires its own planning. A fixed exemption of say, $1M, would point toward setting up insurance trusts to cover the tax on the overage. Note, this isn’t tax avoidance, it simply means if I know my estate will have a tax bill of $500K, I can choose to pay for some life insurance to pay that bill, and leave the full amount to my heirs. It’s the changing rules that cause more confusion and anxiety than anything. I’d bet not one in ten people you meet today can tell you what the rules are for those leaving a large inheritance this year. No, not one.

Even now, there’s talk of our congressfolk ‘fixing’ this year’s rules, and making it retroactive to January. We’ll see. We’ll also see what they do regarding the 2011 return to a $1M exemption.

Any thoughts on the Estate Tax? Fair? Not Fair? Let me know what you think or if you have any questions. By the way, my friends at the IRS have a nice little article titled The Estate Tax: Ninety Years and Counting which you can download.


  • Greg July 27, 2010, 9:08 am

    I’m with Dave Ramsey. The estate tax is immoral. Our elected leaders need to learn how to manage money responsibly and not punish people and their surviving family for the inevitable act of dying.

  • JOE July 27, 2010, 9:38 am

    I appreciate the note and added a link to the Dave Ramsey citation, where he states what you quote.
    My question still remains – does the current law, taxing the untaxed capital gains address this issue to your liking, or to Dave’s point? The farm example certainly goes to the emotional appeal of the reader, I’m sure. We also react differently to the images of (A) The family farm (average value in Iowa is about $300/acre) worth $15M, vs (B) the guy who sits on his gains from investing in Credit Default Swaps.
    I understand the injustice of the farm story. The 2010 estate tax rules effectively allow for unlimited transfers of this property through inheritance. Only on a sale would there be a tax. Or do you feel that any estate tax is wrong, regardless of whether the assets have been previously taxed or not?

  • Evan July 28, 2010, 8:33 pm

    But the cap gains tax is 15% (or at least has been) vs. 45 to 55% Estate Tax, but I guess that is just discussing tax rates and not the underlying moral issue.

  • JOE July 28, 2010, 9:45 pm

    Right, Evan. If we look at the moral issue Dave has with the estate tax, the 2010 law is a compromise, only taxing the gain that the deceased hasn’t paid tax on yet, and only at the time of the sale. If morality is a yes/no issue, there’s no winning. But if you can look at the law as it is now, and see that it saves the potential farm sale to pay taxes. You can leave that farm in the family forever, no tax due. The law next year goes back to a one million exemption and the crazy rates return.

  • Joe Plemon July 29, 2010, 8:21 am

    This is more a political question than a tax question: why can’t Congress just make an estate tax law and leave it alone (as you suggest)? Any thoughts?

  • Len July 29, 2010, 9:43 am

    I seriously doubt that I or anyone else in my immediate family is ever going to be wealthy enough to be affected by the estate tax. (Unless Publishers Clearing House comes through, which, by the way, I am entirely expecting and counting on them to do.)

  • JOE July 29, 2010, 11:27 am

    It’s not tough to build assets of say, $500k (house, retirement accounts, etc) and then two $500k insurance policies. Bam, you are over a million, and at risk for estate tax next year.

  • Jim July 29, 2010, 1:43 pm

    For me it seems ridiculous to get double taxed. their has to be a way that you can keep some of all of the money…

    someone works their whole life to make money and provide for their family and then its taken away, how is that ethical?

  • Len July 30, 2010, 9:46 am

    Just out of curiosity, has anyone commenting on this post ever had to pay an estate tax? If so, and if you don’t mind revealing it, what percentage of your inherited estate was taken by the estate tax?

  • JOE July 30, 2010, 12:13 pm

    I don’t know (to the first question.)
    I don’t mind answering – My father is deceased. My mother’s entire ‘estate’ consists of a house worth about $400K and about $300K tops. I have a sister who is the beneficiary per my request. The estate tax doesn’t impact this situation either way. On my mother in law side, the numbers are not so different, and also are not an issue.

    I can and do have opinions on matters that may never impact me. In my own case, for my daughter, our situation will be better than our parents. Between current assets and insurance, it’s not too tough for otherwise middle class people to blow right through $1M. My $1M term policy was bought when I was young enough that the premium was $600/yr. So is it tough to imagine a working couple both owning smaller policies, a house and their retirement money, now exceeding the $1M number? The exemption goes back to $1M next year.

    To be clear – I’m not looking for total elimination. You understand the 2010 rules don’t mean zero taxes, just a cap gain rate on the untaxed (while living) gains. The difference between 2009, 10, and 11 are so dramatic that each case requires separate planning strategies.

    2009 – a $3.5M exemption, so a couple with moderate planning could leave $7M.
    2010 – no tax on death, just on gains when assets sold.
    2011 – $1M exemption. With no planning, a couple might leave $1.5M and find $500K is taxed. The beneficiary may need to sell the house (if that’s part of the estate) just to raise cash to pay those taxes.

    From a purely selfish standpoint, I say pick one. Stick with it. I can handle any of the three, it’s the jumping back and forth I find so crazy.
    From a planner’s view, I am sympathetic to the “family farm” issue Dave highlights. 2010 rules actually take care of it. 09 and 11 don’t .

    I’ve answered your questions. What do you think is a fair way to address this issue?
    As always, I appreciate the comments my readers leave, thank you.

  • Evan July 30, 2010, 1:34 pm

    I spend almost all my working time preparing and planning for the Estate Tax (other people’s not mine lol). But regardless, No one in my family is black am I allowed to have an opinion on Affirmative Action? No one to my knowledge is gay, can I have an opinion on same sex marriage?

    As far as the family farm there are exceptions and you can use IRC 6166.

  • Financial Samurai July 31, 2010, 12:11 am

    I hope nobody dies next year! Lez go gov’t! Increase the limit to $5 mil+!!

  • George July 31, 2010, 2:18 pm

    We could always have the Japanese solution, where it’s something like a 90% death tax (going by a weak recollection here… need to get the absolute numbers).

    I have a 90-yr-old aunt that probably is near the old $3.5 million threshold as she has been aggressively gifting nieces & nephews (no direct lineage).

    If people figure they need $1.5 million for today’s upper middle class retirement at a safe withdrawl rate of 4%, then $1 million threshold for estate tax is a bit tight. On the other hand, $10 million threshold would be too loose (everybody with a reliable $400k retirement income gets to pass that source to their heirs?).

    Financial Samurai is probably right in suggesting a $5 million limit which could be left alone for a couple decades. That should easily help 95% of nation’s population.

  • David Frees August 16, 2010, 9:16 pm

    Average Joe’s family could be subject to the federal estate tax after January 1, 2011. Why? Well, for starters, the million dollar exemption from tax doesn’t equate to 2 million per couple. It takes some serious advanced planning and the right will and trust provisions to shelter the maximum. And, since the tax applies to life insurance proceeds (unless held in an ILIT- Ittevocable Life Insurance Trust) An average family with a nice home, some private insurance, and some insurance from work could have the tax applied to his or her estate.

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