Why would you pay Estate Tax?

Sometimes the estate tax isn’t all that bad, and according to a recent Smart Money article it may actually be better to choose it over no tax at all! Why would anyone want to subject an estate to taxes if they could opt out? There actually are some pretty sound reasons to consider this. The new tax law gives estate executors (for 2010 estates) the choice between estate taxes and the right to use the new estate tax law.

Here’s why some executors may choose to use the new federal estate tax law instead of avoiding estate taxes altogether: stepped-up basis.

“In 2010 with no estate taxes, larger estates also lost the right to a step-up in basis. “Step-up” means the tax basis of the estate’s assets rise to whichever is lower: either cost or their fair market value at the date of death – or optionally, six months after death (if the overall estate value is lower).”
This step-up is important for two types of estate assets – those that have appreciated significantly (thus earning a capital gains tax status), and those whose costs are difficult to prove, perhaps because records have been lost.

Under the 2010 rules, estates did get a limited step-up in basis, for up to $1.3 million in assets for an individual ($4.3 million for a couple). The rest of the estate’s basis would be based on cost (with some other adjustments) and subject to capital gains taxes at a 15 percent rate.

For example, consider how the 2010 law would apply to an estate asset valued at $8 million, with a cost basis of $1 million. Even though there would be no estate tax, after allocating $4.3 million (assuming a surviving spouse), the federal capital gains taxes would be more than $450,000. Under the new law, however, the estate tax exclusion is $10 million and there are no capital gains taxes. So, in this instance, it would be better to elect to use the new law, claim the $10 million exclusion, and the heirs pay no capital gains tax.

Remember, whichever method you choose, there will be paperwork to file – even if there are no taxes due. The catch? Well, of course there will be a catch. The IRS has not yet created the forms!
Suggested key words: federal estate taxes, step-up basis, capital gains tax