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Jay Young

Dying in 2011 Might Be a Bad Idea

Harford Business Ledger: December 2007

2011 will be a big year. After all, it's the year the Base Realignment at Aberdeen Proving Ground is scheduled to be fully completed -- which is forecast to deliver significant economic benefits to the businesses of Harford County (we hope!). But, coincidentally, 2011 is also the date that the federal estate tax reappears in full force, and with a vengeance.

Now, of all our country's taxes, the federal estate tax strikes me as the most unfair -- even bordering on ludicrous -- because it's a tax levied for the privilege of dying! The estate tax is levied against the value of your entire net worth at your time of death, and that "net" will include some things most people don't expect -- such as life insurance policies. And it's huge: a tax of 45% on all amounts over the exemption amount.

The exemption has been increasing year by year, but all that is scheduled to change dramatically -- in 2011. The current administration has repeatedly attempted to eliminate the tax permanently and entirely, but without success. In a typical political compromise, an attempt to lessen the impact of the tax was worked out in Congress, but almost all of those benefits disappear on January 1, 2011. Here is a brief history so you will understand what's coming.

When the current administration took office the federal estate tax ranged from 35% to 55% and the exemption amount was $600,000. So, if you died owning assets worth less than $600,000, you paid no federal estate tax. If your assets exceeded $600,000, you were taxed on a graduating scale from 35% to 55% of the value of those "above the exemption" assets, and the death tax had to be paid within nine months of death.

Of course, such a tax rate may have wreaked havoc on the rich and famous, those who own sports franchises and anyone of significant wealth (provided, of course, that they hadn't taken certain steps to shelter their wealth), but, more importantly, it also wreaked havoc on an increasing number of average Americans, because, thanks to inflation, a $600,000 net worth quickly became more attainable. In Harford County the estate tax worked particular hardship on the owners of family farms, because on their deaths, the IRS valued their land at its full development value. So, if a family farmer died owning 100 acres in Harford County, the IRS valued the property as a 10-lot subdivision and wanted to collect a tax at the death of the farmer on the value of the subdivision (keep in mind that there is an exemption from this tax between spouses, so the tax only hits when the second spouse dies -- a little relief, but not much)!

The law passed at the inception of the current administration lowered the tax rate incrementally over a multi-year period from 55% to the current 45%, and also immediately increased the exemption amount from $600,000 to a $1 million. The law then provided that the exemption amount would increase to $1.5 million in 2004, $2 million in 2006, $3.5 million dollars in 2009 -- and that for 2010 the federal estate tax would be abolished.

So far so good -- reasonable and understandable. But -- not so fast. Because the votes could not be obtained at the time of the passage of the legislation to abolish the federal estate tax forever, most of the benefits of the legislation disappear in 2011. In other words, on January 1, 2011, the federal estate tax returns and the exemption amount decreases to a "mere" $1 million. While a million dollars is still a lot of money, "it ain't what it used to be." With the dramatic increase in real estate values over the last decade, many people are living in houses which, as your mortgages are paid off, may well be worth a million dollars by 2011 -- and that's just your house. Remember that the tax applies to all of your assets. You may want to keep all of this in mind when evaluating Presidential candidates for the upcoming election!

Above, I mentioned "certain steps to shelter wealth." Indeed, there are trusts which can be utilized to enhance the exemption. For example, let's take the situation of a husband and wife, where each one currently has a $2 million exemption. If one spouse leaves everything to the surviving spouse (remember, that transfer is tax-free), the surviving spouse now has $4 million of assets but still only a $2 million exemption. The prior exemption of the first spouse has been effectively wasted. But there are trusts that can be utilized to capture the exemption of the first spouse to die -- thus effectively SHELTERING that exemption and lowering the exposure of the overall estate to the death tax. If you currently have a taxable estate (or if you will in 2011 if something doesn't change), you should update your planning accordingly.

If nothing is done legislatively prior to 2011, this issue will affect a lot more people a lot more dramatically. Stay tuned -- and be prepared!

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