Your Guide To The Estate Tax

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OCEAN CITY – When it comes to the estate tax, a host of changes may affect millions more families. This Q&A can help you protect your legacy in light of the new laws.

Q. What’s going on with the estate tax? Is it gone for good? Or will it potentially apply to even greater numbers of people?

A. Thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001, estate taxes and generation-skipping transfer (GST) taxes have been eliminated, at least for 2010. If Congress doesn’t act before the end of the year, the estate tax will be back, with a tax-free exemption of $1 million and a top tax rate of 55% for 2011. That’s far harsher than in 2009, when the exemption was $3.5 million and the rate was 45%. "As a result, even if you don’t consider yourself wealthy — even if you just own some real estate, for example, and carry a life insurance policy — your estate could be subject to the estate tax next year," says Scott Cooper, Managing Director of Merrill Lynch’s Wealth Structuring Group.

Q. What should I do now to protect my estate?

A. One of the simpler strategies is to consider using your annual $13,000 tax-free gift allowance. Under current law, each spouse can gift up to $13,000 per person, either outright or by placing it in a trust. If, say, you and your spouse have two grown children who are married with kids, you can shelter $80,000 to $100,000 a year from both gift and estate taxes. One caveat: These gifts are irrevocable, so you don’t want to over-gift today and risk outliving your savings later.

Q. What other estate tax concerns do I need to know about?

A. Everyone should understand two key issues. First, although the federal estate and GST taxes don’t apply this year, many states still have estate taxes. In some states, such as New York and New Jersey, those taxes are as high as 16%. States also have their own exemption allowances, so it is important to understand your state’s tax code.

The second concern is that even without an estate tax this year, beneficiaries who inherit appreciated assets may have to worry about income taxes. Before 2010, the cost basis of inherited investments — which is used to determine possible capital gains taxes when assets are sold — was stepped up to market value on the day the owner died. But this tax advantage, which could significantly reduce the amount of taxable gains, ended when the federal estate tax disappeared. In 2010, it was replaced by a rule that carries over the original cost basis of inherited property. So if you inherit stock that your grandfather bought in 1940, for instance, your cost basis for capital gains tax purposes starts with his 1940 purchase price. The good news is that this year’s rules do allow an executor to increase the cost basis of assets that a spouse inherits by $3 million and to award other inheritors a flat step-up of as much as $1.3 million. Q. But Congress could still change everything, right?

A. One of these three scenarios seems possible:

Congress does nothing; the estate and GST taxes remain repealed for 2010; and the higher rate and lower exemption go into effect next year.

Congress acts to revise the estate and GST taxes for 2011 and beyond.

Congress acts to revise the rules for this year, possibly even retroactively back to January 1, 2010.

"Most people in Washington believe that the longer it takes for Congress to deal with the issue, the less likely it becomes that anything would be imposed retroactively," Cooper says.

Even if Congress renders all these current issues moot, this year’s confusion serves as an important lesson: Everyone, regardless of wealth, can benefit from having a will and a well-thought-out plan for how they want to transfer their wealth to their heirs. And because Congress often changes tax laws, it’s important to review your documents and strategies on a regular basis to ensure that they still fulfill your intentions. Now would be a good time to check in with your financial advisor and attorney about any adjustments you may need to make to reflect current tax conditions.

(A Merrill Lynch Wealth Management Advisor. She can be reached at 410-213-8520.)

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