Estate Tax in Limbo

In 2010, things get comical. The current dumb rules say that the estate tax will disappear in 2010. That means you can die estate tax free that year. So for all you planners out there, feel free to walk into traffic sometime during 2010.

Ay, there's a rub. (There always is.)

While the estate tax disappears in 2010, so does the step-up in basis on assets over $1.3 million.

Here's how that affects your wallet. Let's say Great Aunt Milly wants to bequeath shares of stock to you that she bought at $5. We'll presume that in 2009, the stock will trade at $30.

If Milly dies in 2009 and leaves you the shares, you'd get them at their fair market value -- or what they're trading at on the day of her death. So your basis (a.k.a. the original cost in the shares) would be "stepped up" to $30. That means that if you sold the shares, you wouldn't owe any capital gains tax because the difference between your cost ($30) and their current value ($30) is zero. So, there's nothing to tax. Excellent.

But say she dies in 2010 and the stock is still trading at $30. While there's no estate tax on her assets, you've lost your step-up in basis. You inherit her original cost -- a.k.a. basis -- at $5. Then, if you sold in 2010, you'd owe capital gains tax on $25 ($30 minus $5).

An even bigger issue would be if poor Great Aunt Milly didn't know her original cost. You'd have to somehow figure out when she bought and then determine her original price. Holy paperwork nightmare.

That's your 2010 headache.

Move on to 2011. The estate tax and the step-up in basis come back, but the estate-tax exclusion is scheduled to drop to $1 million for a single guy. And having a $1 million estate is very obtainable. So, we regular folks have to start worrying.