Because the federal estate tax laws will change in each of the next few years, it is difficult for many individuals to plan for the efficient transfer of wealth to their heirs. Although many of you are aware of the general state of flux of the federal estate tax laws, understanding some basic details may help you to take action in this regard.

Estate Tax Exemption

In 2008 the federal estate tax exemption is $2 Million.
In 2009 the federal estate tax exemption is $3.5 Million.
In 2010 there is not federal estate tax.
In 2011 the federal estate tax exemption is $1 Million.

If you had an estate of $5 Million and wished to transfer it to your children, if you died on December 31, 2008, the estate tax would be $1.35 Million. If however, you died one day later on January 1, 2009, the estate tax liability would be $675,000. If you died one year later on January 1, 2010, there would be no estate tax liability. If you died two years later on January 1, 2011, there would be a federal estate tax of over $2 Million!

Many experts think that the laws will change before the year 2010. Congress however, has been unsuccessful to date in their attempts to pass this new legislation. Currently there are two bills before Congress. A Senate bill which provides for a $3.5 Million exemption and a House bill which provides for a $2 Million Exemption. The House bill restores the unified gift and estate tax credit, provides that a surviving spouse be able to use the unused exemption of his or her deceased spouse and restores the state death tax credit. Both of the bills are in committee now. The federal estate tax provides many billions in revenue each year so although no one likes the “death tax,” it has been an effective tool for raising revenue for the federal government.

In addition to the federal estate tax laws, most states have their own estate tax. Prior to 2002, most states had laws that tied their estate tax to the federal estate tax laws. Since 2002, many states have untied their estate tax laws from the federal estate tax laws because they did not want to lose the revenue that was generated from these taxes. Hence most individuals now have to plan separately for the state estate tax laws and the federal estate tax laws keeping in mind that each state is different.

Carryover Basis in 2010

In the year 2010 only, carryover basis rules will be in place. Since there is no estate tax in 2010, Congress needed to address the question of the “step-up” in the cost basis of the assets held by a decedent’s estate or heirs. In 2010, there is not an automatic “step-up” for all of the assets that comprise a decedent’s estate. Instead, a carryover basis will apply to assets having over $3 Million of appreciation inherited by a decedent’s spouse, and assets having appreciation of more than $1.3 Million inherited by others. The $1.3 Million is the amount for all heirs combined, not for each heir. For inheritances below this amount, the current law for stepped-up basis rules applies in 2010.

Action Necessary

Although it may seem easier to take a “wait and see” approach, putting off decisions in this regard, could cost your family dearly. The laws are complicated and there are many moving parts. I recommend speaking to your financial advisor and your estate planning attorney annually to make sure that your estate plan is still effective in allowing an efficient transfer of assets to your heirs during this time of uncertainty. If you have recently lost a spouse or family member, and will inherit from that person, seek professional assistance from an estate planning attorney as soon as possible. There are ways to plan for reducing estate taxes, even after your spouse or loved one passes, if done within the first nine months after their death. It is a good idea to speak to your financial advisor and your estate planning attorney about all changes that you have made or will make with respect to asset ownership, your will, trust agreements, beneficiary designations, family (i.e. new marriage, divorce, birth or death of a child). These changes can affect your estate plan and your advisor(s) must know about them in order to ensure that your overall estate plan is still sound.

IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, you are hereby advised that any written tax advice contained in this answer was not written or intended to be used (and cannot be used) by any taxpayer for the purpose of avoiding penalties that may be imposed under the U.S. Internal Revenue Code.