TAX NEWS - 2010

Tax Q&A: Estate tax issue

Dear Michael: We have been following your columns on the estate tax issue. Is it really possible that estate taxes may return to anything over and above $1 million? If so, what is the rate for taxation over and above the $1 million? - Taxed About Taxes.


Dear Taxed: The Republicans and the Democrats were working on a bill that would have returned estate taxes to the 2009 limits of $3.5 million without taxation with the excess being taxed at 35 percent. In addition, this amount would have been raised over time, much like the old tax bill that raised from $1 million up to $3.5 million. The new amount would have grown to $5 million over time, although the exact specifics are unknown as to what time period this would be.

Another interesting element of this estate tax bill was the ability to pre-pay your estate taxes at a discount, if you were using a pre-payment trust.

However, Democrats backed out of the bill when they found they did not have a majority of their senators willing to vote for such a bill. In polling their senators, the Democrats found almost 80 percent of the senators were opposed to such a large tax bill.

Again, if this bill is not acted on by Dec. 31, 2010, the estate tax will revert back to a $1 million exemption with the excess taxed at 55 percent. This would mean on an "average" farm in North Dakota of approximately $2 million net worth, the taxes would be in excess of $500,000 to the estate of the decedent.

To follow up on a previous column, for people who set up "life estates" and expected to avoid estate taxation, remember whatever percentage value equaled the value of the transfer will be deducted from the exemption at the time of death.
 
For example, if I gave $1 million worth of property to my children and retained a joint "life estate" in the property with my spouse, and we were both age 70, the value of the gift of this deed would have been approximately 40 percent of the current market value of the property to my children - or $400,000. This comes from the IRS table CODE FOR VALUATION OF LIFE ESTATE ASSETS 75-02-02.1-320 - Valuation of life estate assets.

The double whammy occurs when, at the time of the second death, the entire value of the property the decedent had a life estate interest in is included in the decedent's estate for the purposes of estate taxes.

In the above example, if each spouse used $200,000 from their Unified Credit by each using half of the gift given when they made the "life estate" and "residuary deed" gift to their children, each spouse would only have $800,000 in Unified Credit left if estate taxes return to a $1 million exemption.
   
Upon the first spouse's death, the entire "life estate" interest would roll over to the surviving spouse. If the property appreciated from $1 million to $1,300,000, by the time of death, the entire $1.3 million would be included in the decedents' estate and he or she only has room for $800,000. This would leave $500,000 taxed at 55 percent or $275,000 of estate tax on the "life estate" property.

The GOP has made it know they want an exemption equal to $5 million - if not now, then over time. However, with 80 percent of Democratic senators opposed to this amount, this cannot pass unless the majority is changed in the fall elections to the GOP. Recent elections haven't shown any prominent shift one way or the other as most elections to this point have shown voters voting against incumbents - whether they be Demo_crat or Republican.

If this trend continues, neither party in Congress will be closer to having a majority of votes, making the possibility of coming up with an agreement acceptable to both parties on the estate tax bill prior to the end of the year deadline less likely.

In either case, it appears that estate taxes are going to be a part of our future - whether the exemption is at $1 million (possible), $3.5 million (50-50 chance) or $5 million (highly unlikely). With dollar values in farmland, equipment, grains or other farm commodities held absolutely soaring in value over the past three years, a very high percentage of farmers and ranchers will need to be concerned about estate taxes.

The only question will be which exemption will be in play after 2010? If it returns to $1 million, watch out - taxes could occur on over 50 percent of the farmers and ranchers out there.