Most people don't realize we have two systems of taxation. One taxes income as it's earned; the other taxes wealth as it changes hands.
During a person's lifetime, the latter is known as the gift tax. At his or her death, we call it the estate tax, and it could carry significant tax consequences for you and your beneficiaries. That's why estate planning is so important.
Each state has its own rules for state inheritance taxes. And then there's the federal estate tax. For 2007 and 2008 tax returns, there's no federal estate tax if your estate is worth $2 million or less.
For the vast majority of Americans, that ends the discussion.
Even if your income is modest, however, you may not be off the hook. Do you live in a community where real-estate values have risen sharply and you've owned the property for a long time? Have you built up a stake in a company whose stock has shot sky-high over the years, like, say, Google? If you fall into one of these scenarios, pay attention.
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The $2 million "exclusion amount" increases to $3.5 million for 2009, then becomes unlimited for a year. That means for 2010 there will be no federal estate tax, regardless of how big an estate you leave. For 2011, the exclusion amount will revert to the 2001 limit, unless Congress comes up with a new law.
I expect to see lots of dying rich people hooked up to machines at the end of this year to keep them alive until 2010.
But we're talking about the Internal Revenue Service here, so nothing is simple. Die on Dec. 31, 2010, and your beneficiaries will pay zero estate tax. Die the next day, and the exclusion amount will be $1 million. That's why it's so important to sit down with a professional if you think your estate might be big enough for the tax to hit.
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Congress has been talking about amending the estate tax rules for three years now, with no progress. Now that the 2008 elections are over, I suspect we will get a permanent exclusion of about $3.5 million per person, which, with a properly drafted will, will exclude estates of $7 million or less for married couples.
In the meantime, be careful! Simple things can empty your pockets. For example, if you leave 100% of your assets to your spouse, your estate pays zero tax because of the marital deduction. But you're losing the value of your exclusion and potentially subjecting an additional $2 million-plus to taxes when your spouse dies. Your children will not be happy!
If you're going to be a potential victim of this "death tax," start planning now. People don't plan to fail; they fail to plan. The earlier you start planning, the more opportunities you have to minimize or potentially eliminate this tax hit.
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