The estate tax, or inheritance tax, was repealed for 2010 but reinstated in late December. Many individuals are wondering what this shift may mean for those who inherited estates in 2010, as well as for those who may do so in 2011.
The estate tax is complicated. The minimum worth of the estate before the tax kicks in varies, as does the actual amount of the tax. Consumers should be aware of changes in the estate tax in case they inherit an estate or are elected the executor of an estate.
The estate tax is a tax levied on the assets left behind when someone dies. In the U.S., the tax fluctuates and many estates are not affected by it (when an estate totals below a certain amount). Because the estate tax was repealed for 2010, any estate originating in 2010 was not taxed regardless of the worth of its total assets. However, on December 17, 2010, a new law was signed that retroactively instated the estate tax to the beginning of 2010.
The reinstatement does not have to be as complicated as it seems. If you are an heir to the estate of someone who died in 2010, you now actually have a choice between paying the 35% estate tax (for estates over $5 million), or not paying.
But think twice before making what seems like the obvious choice. If you elect not to be covered by the estate tax, the assets you inherit will not receive a stepped-up basis for future sales. Usually, when a person sells something he or she inherited, the tax paid on the gains from the sale is based on the value of the property at inheritance.
A quick illustration will help. Say you inherited a house that your parents bought for $100,000 (their basis), but which, when you inherited it, was worth $200,000. Then say you sell the house for $300,000. Without the stepped-up basis, you have to pay tax on the difference between the amount it sold for and the amount your parents spent on it, or $200,000. In other words, your parents' basis became your basis. With the stepped-up basis, however, you pay tax on the difference between the sale price and what the property was worth when you inherited it, or $100,000, which is a much more favorable result for the taxpayer.
Going back to the choice of 2010 estate tax coverage, if you elected not to be covered by the estate tax, this means that when you sold your property, you would have to pay capital gains tax on $200,000. If you elected instead to be covered by it, you would pay capital gains tax on only $100,000.
Making the Tax-Savvy Choice
Most of us do not even have to worry about the 2010 decision. The estate tax only applies to people who inherited estates worth over $5 million, so if you inherited an estate worth less than that, not only can you ignore any estate tax issues, but you also get the stepped-up basis in the property. For those who have inherited estates worth more than $5 million, they should carefully consider their situations before deciding whether to opt-out of the retroactive estate tax rules. For some large estates, opting-out will certainly be the best option, since the capital gains tax is currently only 15%, while the estate tax would be 35%.
For individuals who inherit estates in 2011, there will be no choice. You will get the stepped-up basis in property for capital gains purposes, and you will also be subject to a 35% estate tax if the estate is worth more than $5 million. Of course, when dealing with such large amounts of money, it's always advisable to contact an experienced tax attorney to be sure you are making the right decision.