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Watch your step-up: Despite estate tax elimination, liabilities carry over

by Carol Lundberg
William E. Sider has heard plenty of gallows humor during this year of life without a “death tax.”

With the repeal of the estate tax, and the uncertainty surrounding whether, and how, it will return in 2011, he and his colleagues are entitled to a chuckle, after all.

“They say that the repeal is the only last tax loophole out there, but it has a pretty stiff price – death,” said Sider, a partner at Southfield-based Jaffe Raitt Heuer & Weiss, P.C.

But in all seriousness, he adds, there’s an additional price heirs may have to pay: they’ve lost the opportunity to step up the basis of assets that, before this year, eliminated tax on inherited capital gains. It’s been replaced by a carryover basis regime, which will calculate tax on property’s value at the time of inheritance.

This will affect far more heirs than the estate tax, said Sider, particularly in families where the largest – or only – piece of the estate being passed on is real estate or the family business.

In 2001, Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001, which increased the estate tax exemption from $675,000 in 2001 to $3.5 million in 2009, and repealed the estate tax altogether as of Jan. 1, 2010.

But it didn’t set any budget rules beyond this year.
So, next year, if Congress does not address the estate tax issue, the estate tax exemption would revert to its 2002 level, $1 million, and would reset the maximum estate tax rate at 55 percent.

Along with the repeal of the estate tax was the elimination of the step-up basis.

So, under the step-up regime, if a man started a business 40 years ago and passed it on to his heirs, the heirs would not be taxed on the gain in value over the four decades, said Bingham Farms attorney Howard B. Young of Weisman, Young & Ruemenapp, P.C.

“Congress did throw us a bone and exempted the first $1.3 million or $3 million for some surviving spouses,” Sider said. “But there are a lot of taxpayers who are going to be affected by this.”

It’s the step-up that has Young anticipating that not only will Congress reinstate the estate tax, but it will do so retroactively to the first of this year. Without reinstating the tax, it can’t address the step-up debacle, he said.

“If they don’t make it retroactive, there is an unexpected effect: many persons of lesser wealth would end up paying taxes they never would have paid if the law was the same as it was in 2009,” Young said. “So someone of more modest means would have an income tax they never would have had.”

There are far more people who could be affected by the step-up basis than there were people who would have been affected by the estate tax, he added.

“Here’s an example,” Sider said. “Let’s say Dad bought a vacation home on Mackinac Island, and back in the 1950s it was worth $50,000. But he dies today, and it’s worth $2 million. It’s the only asset he owned. Last year, the family wouldn’t be on the hook for the taxes because it would have been within the existing unified credit amount,” which was $3.5 million last year.

“Now,” he added, “the beneficiary has a tax problem because they’re sitting on pregnant gain. They’ll be on the hook for the taxes on $700,000, the difference between the [$1.3 million] exemption and the value of the house.”

Sider has tried to warn his clients that their estates could face this type of tax liability if they die this year.

At the beginning of the year, the firm sent out an alert to clients, but the response thus far has been mainly silence. And he has gently suggested to some clients that they might want to consider implementing some of the short-term fixes that could cover their estates this year while Congress sorts out what it will do about the estate tax next year.

But they’re not particularly keen on discussing that either, he said.

“People scrimp and save, but they really don’t like to think about or discuss estate planning,” said Eric S. Glick, of Thav, Gross, Steinway & Bennett, P.C. in Bingham Farms. “There’s a generational thing where younger people seem more willing to talk about estate planning. Older clients really don’t want to talk about death and money.”

He’s tried to spread the word and offer opportunities for clients and potential clients to approach him, speaking at seminars and mailed alerts. But he said he’s also had limited response.

Glick has pointed out to clients that failing to plan for the worst could land their estates in probate.
“If they tend to be very private people, that’s scary to them. Anything that gets filed in probate is public information,” he said.

But he acknowledges that, although lawyers aren’t fond of the uncertainty in the estate tax limbo, clients are even less eager to think about it.

“A lot of clients just say that they’ll take their chances for this year and sort it out next year,” Glick said.

Sider said that’s a possibility, and that all of the learning, planning and client education he’s worked on will be for naught.

“What has started to surface is the idea that, in the next few weeks and months, maybe Congress will do what they’re really good at,” Sider said. “Which is nothing at all.”

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