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MAKING CENTS OUT OF THE NEWS
Blog #49
(December 24th, 2009)
OFF INTO THE SUNSET - CONGRESS AT ITS IRRESPONSIBLE WORST
By Tom McAllister, CFP®
When I talk of Congress being at its irresponsible worst, you might imagine I'm referring to the Health “Reform” Act, but I'm not. (That I will discuss next week in my quarterly newsletter!) I’m referring to our legislature being remiss in its obligations when it comes to the estate tax.
As matters stand now, the estate tax is set to "vanish" or "sunset" for one year, and then to be reinstated in 2011. Subsequent steps being considered could dramatically affect millions of taxpayers, and not for the better. That’s because there are two kinds of tax that affect inherited assets. One is the estate tax itself; the second is the income tax on capital gains.
The reason financial advisers are so concerned about the estate tax repeal is that an important income tax “break” will be repealed along with it. Called the “step-up in basis”, this aspect of income tax law now values inherited assets at their worth on the date the person who bequeathed them died. Beginning January 1, 2010, however, gains on inherited assets will be measured using original cost.
To clarify the matter, let's look at an example. Several years ago, John received from his parents a gift consisting of shares of Microsoft stock. The parents had purchased these shares quite a number of years earlier at a cost of $100,000. Today the shares are worth $6 million.
Now, were John to die this week (in 2009), his heirs would inherit $6 million of stock and owe no capital gains tax on the difference between the original purchase price and the price on the date of John's death. The base value would "step up" to $6 million. True, the estate would theoretically be subject to estate tax. However, with good estate planning by John and his wife, their heirs might escape that as well, because a couple can shelter up to $7 million from federal estate tax.
Suppose, instead, John dies two weeks from today, in 2010. Heirs would receive $6 million worth of Microsoft, but, when those shares are sold, capital gains tax will be calculated on the difference between $100,000 and the sales proceeds at the time, without the protection of the "step-up" in capital gains. Even without any further rise in the price of Microsoft stock, John's wife could owe capital gains tax as much as $885,000!
Congress is proceeding without regard to the approaching planning catastrophe for upper middle class American taxpayers. President Barack Obama blocked a short-term extension of current law on Wednesday, but Senate Finance Committee Chairman Max Baucus (D., Mont.) said he will try to move legislation early in 2010 that ensures there won't be a window where wealthy estate owners who die will escape the tax.
Frankly, I did not believe Congress could be any more ineffectual than it was in its initial reaction to 2008"s financial meltdown. Now I see the so-called Health "Reform" Act being passed in spite of very high public opposition, and am astounded at the lack of comprehension on the part of our legislators of the ramifications of the estate tax "repeal". Yes, I fear, matters involving our Congress have gotten worse, much worse.
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