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Lack of estate tax creates problems for people with older wills

The federal estate tax expired at the end of 2009, and this has created a serious problem for many people who haven’t revised their wills in a while.

The tax applied in 2009 to estates of more than $3.5 million. It is slated to come back in 2011, and apply to estates of more than $1 million. Most people expected that Congress would “fix” the estate tax before it expired, and there would be a new exemption amount, such as $3.5 million, for 2010 and beyond.

However, Congress has done nothing so far – at least as of when this newsletter was written. And while it might seem great if there is no estate tax in 2010, it’s actually a problem in many cases…even for people whose estates aren’t anywhere near $3.5 million.

Here’s why: Many older wills were set up to avoid taxes by giving children an amount of property equal to the exemption amount, and having the rest go to the surviving spouse. For instance, if the exemption amount were $675,000 (which is what it was 10 years ago), then $675,000 would go to the children (or to a trust for the children), and the rest would go to the surviving spouse.

But in 2010, there’s no exemption amount. So in some cases, the result is that the entire estate goes to the children, and nothing goes to the surviving spouse.

Now it’s possible that Congress will fix this by retroactively reinstating the estate tax for 2010. But it’s also possible that it won’t – or that even if it does, the changes it makes won’t apply to the particular language in your will. So if you have an older will with such a provision, it could be very wise to revise it now so you don’t wind up accidentally disinheriting your spouse.

There are other problems, too. For instance, while the federal estate tax has disappeared in 2010, so has the “step-up” in basis.

Suppose you purchased shares of stock many years ago for $25,000, and they’re now worth $100,000. If you died in 2009, your heirs would get those shares with a “stepped-up” basis of $100,000, so if they sold them right away, they wouldn’t owe any capital gains tax.

But if you died in 2010, your heirs would get those shares with a basis of only $25,000, so if they sold them right away, they would owe tax on a $75,000 capital gain.

This change could also create a major headache for many executors, who will now have to determine the original purchase price of homes, stocks and other assets – often decades after they were purchased, and with scant records. This could be very time-consuming and expensive.

Therefore, it might be wise to reconsider what property goes where in the event that Congress does nothing. You might, for instance, want to give assets with a low basis (or a basis you can’t easily determine) to charity, rather than those with a high basis. Also, there are complicated rules that may allow you to “assign” a stepped-up basis to certain assets, thus reducing the problem.

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