Wednesday, December 30, 2009

Nightmare on Pennsylvania Ave

I’ve been beating on the State of California a bit (it’s so easy) so I thought I would switch topics to our friends in Congress.

In 2001, Congress enacted estate tax reform which provided that the estate (aka inheritance) tax would expire Jan 1, 2010 for one year only. I wrote about this topic in an earlier piece and opined that Congress would “fix” the sunset provision by now and likely settle the amount that a decedent could pass tax free to heirs at $3.5 million. In what has been labeled by some as “congressional malpractice”, the Senate failed to take up important tax legislation that had to be done by year end. As a result several expiring tax breaks including tuition deductions, R&D credits, charitable donations from IRA’s and the estate tax were not addressed.

So now, we have a situation where people who pass away after Thursday will not have their estates taxed at all, but those passing away today will. There are credible reports of families with wealthy members on life support waiting until Friday to pull the plugs, solely for tax purposes. When you figure it could be huge amounts of money in the balance, it seems likely that this is true.

Not going to affect me you say? Don’t be so sure. One of the principles built into tax law is that of a stepped up basis for inherited property. Many people benefit from this provision, particularly surviving spouses, who may ultimately sell highly appreciated assets they receive by way of inheritance. It enables an heir to escape paying taxes on historical gains on inherited property. As part of this new change, we now have a formula to determine basis starting with historical cost. This means that if you sell the family home inherited from your grandparents, your tax cost may be what Gramps paid for the place. Just imagine the nightmare trying to determine historical basis for property bought decades ago by someone who is no longer around! Tax professionals across the nation are cringing at this accounting nightmare, and heirs will end up paying far more in taxes on capital gains as a result.

It is unclear whether any fixes can or will be attempted retroactively. If so, they will likely be challenged in court. We will just have to wait and see what, if anything, our legislators do to fix this mess when they return from their holiday recess.


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