Inside The Inheritance Tax Mess

Copyright (c) 2010 Brian Fricke

I think by now most of you have heard that there’s no inheritance tax or estate tax this year. So if you’re planning on passing away anytime soon, this would be a good year to do it — at least from an estate planning point of view. I’m kidding, of course. But in case you decide to take me seriously, you should know there’s even a gotcha buried in this “giveaway” law.

The little gotcha comes in the form of increased capital gains tax. Here’s how the gotcha is going to getcha. Last year, if you inherited an asset, your tax basis/cost basis was the value of that asset on the date you inherited the asset. So if you inherited a stock from a relative or parent that they bought 30 years ago for $50,000, even if the stock is now worth $400,000, you would not pay taxes on the $350,000 profit. This is because your stepped up basis was the market value the date you inherited the property. This was true regardless of what the asset was – it could be real estate, stocks, bonds, mutual funds or whatever the case may be.

Well the rules are different this year. Now, when you inherit property or assets (stocks, bonds, mutual funds, real estate) they are not given the stepped up tax basis. Which is going to put a whole lot more people in the position where they’ll have to pay capital gains tax.

So it’s kind of a good news/bad news scenario. The good news is you don’t have the estate tax, while the bad news is you’ll possibly have to pay capital gains tax. I say possibly because there are some exemptions or limits — the first $1,300,000 of assets are not subject to this capital gains tax, but anything above that is. There also is a provision for people who are inheriting a small business, and also for surviving spouses.

I’m honestly not sure how this is going to play out the rest of the year — everything that we’re reading seems to suggest that at some point this year, Congress is eventually going to get around to fixing the problem. They do recognize that this capital gains situation is a mess, and the consensus is that this year, and if not, definitely next year, the estate tax exemption will be changed.

And what a mess it is. Last year everybody had a $3.5 million exemption, or $7 million for a couple. This year there is no estate tax, regardless of the size of your estate. And then next year it will be a $1 million dollar exemption, or $2 million for a couple, assuming estate planning is properly done. There just doesn’t seem to be any logic behind any of this. From what I have heard, when the law is fixed they may make it retroactive to the beginning of this year. Stay tuned for when we know of an actual, definite law that’s in place – when there is we will let everyone know about it and the impact it might have on your personal finances.