The Federal Estate Tax Is Dead: Now What?

Source: SmartMoney It’s your money. Be Smart. January 7, 2010

Washington, we have a problem. You just let the federal estate tax expire and the citizens are confused. Nobody saw this coming, least of all me. Now that I’ve recovered from falling off my chair, let me explain how we got here and my take on what you may need to do (or not do) right now.

The Tax Was Programmed to Die This Year (and It Did), but the Story Is Not Over

Since 2001, the federal estate tax has always been scheduled to expire this year. But it was always a two-part story, because the tax is also scheduled to come roaring back with a vengeance in 2011 and beyond. In those years, estates worth as little as $1 million are lined up for a tax whipping. No informed person ever thought these two things would be allowed to happen because, taken together, they make no sense.

So we all sleepily assumed Congress would step in to continue the relatively generous (by historical standards) $3.5 million federal estate exemption we had in 2009. Some thought it might even get bumped up to $5 million or so.

No such luck. Our Congressional pals did nothing about the estate tax last year, and it could be months before they get around to tackling it this year. By then, the issue may be so contentious that all previous predictions about what might happen (from guys like me) get thrown out the window.

To sum up, we are now in a very strange place with no federal estate tax on those who happen to die this year and a confiscatory tax looming over those who happen to die later on. This bizarre situation will continue until the law gets changed, which I’m still pretty sure it will. Meanwhile, you want to know what to do today. Here’s my advice.

You Are Married With an Estate Worth Over $3.5 Million

If you fall into this rather well-off category, I hope you have already set up a tax-saving estate plan. If so, you should probably leave it alone unless you have one of the two problems I’m about to explain.

First, your existing plan may be horribly flawed if it calls for giving as much money as possible (rather than a specific dollar amount) to your kids and/or grandkids without triggering a federal estate tax bill, with the rest then going to your spouse. Last year, this plan would have directed $3.5 million to the kids, which presumably was fine by you. But with the federal estate tax currently missing in action, dying now would result in your spouse getting absolutely nothing. All your assets would go to the younger generations. If this is not what you intend, please run (don’t walk) to your estate planning pro and get the problem fixed. I think the common-sense solution is to stipulate that your spouse would get a specific dollar amount or percentage of your estate with the rest going to the youngsters. You may have to retool your plan later when Congress finally does whatever it does. Oh well. Cross that bridge when you come to it.

The second potential problem is much less serious, and you may decide to not even worry about it. Say your current estate plan calls for leaving the specific amount of $3.5 million to your kids and/or grandkids, with the rest then going to your spouse. Last year, this was a good plan. It avoided any federal estate tax hit by taking full advantage of last year’s $3.5 million exemption. As of today, however, you can leave as much as you want to the youngsters with no federal estate tax due. So if your existing plan gives your spouse more than he or she really needs, you can change the deal and leave more to the youngsters and less to your spouse. Once again, you may have to rework your plan when Congress finally takes action.

You Are Married With an Estate Worth Less Than $3.5 Million

There won’t be any federal estate tax hit if you die today, and there would not have been one had you died last year. We can only hope the same will be true if you die next year. In any case, you don’t need any tax-saving estate plan right now. But if your plan was set up several years ago, I recommend checking in with your estate planning pro to make sure your house is still in order. You don’t need to run. You can walk.

You Are Single With an Estate Worth Over $3.5 Million

Last year, you couldn’t leave over $3.5 million to loved ones without triggering a federal estate tax bill. So your existing plan might still call for your estate to make enough charitable donations to whittle its net worth down to $3.5 million before giving that amount to your loved ones. Since you can now leave an unlimited amount to loved ones with no federal estate tax due, you might want to make a change. Of course, you may have to revisit your plan after Congress makes its move.

Don’t Forget About State Estate Taxes

Yes Virginia, it’s not just the feds that charge estate taxes. So if you decide to update your plan because of the federal estate tax considerations I’ve mentioned here, make sure the changes don’t unnecessarily increase your exposure to the state tax collector. This is yet another good reason to visit your professional adviser pronto.