2010 – AN UNUSUAL YEAR FOR TAX LAW

There is no federal estate tax this year.  Since the State of Hawaii has no inheritance tax, Hawaii residents can die this year with any amount of assets and pay no death taxes at all.  This is only for the year 2010.  For someone dying in 2011 or later years, any assets not inherited by a spouse or a charitable organization will be taxed, starting at a tax rate of 41% from the first dollar over 1 million, and going up as high as 55% for amounts over 3 million dollars.

The strange law this year and next year is a result of the 2001 tax act.  The 2001 tax act was supposed to get rid of the estate tax.  The 2001 tax act provided that the amount exempt from estate taxes would be $1,000,000 in 2002 and 2003, $1,500,000 in 2004 and 2005, $2,000,000 in 2006, 2007 and 2008, $3,500,000 in 2009, with no estate tax at all in 2010.  However, the bill that passed Congress contained a “sunset clause.”  The sunset clause provided that unless Congress in the future voted to extend the law, this new tax law would expire after December 31, 2010.  Like Cinderella’s beautiful carriage turning back into a pumpkin, just after midnight on December 31, 2010, the tax law will go back to what it was in 2001, which was that only 1 million dollars is exempt from the estate tax.  Therefore, there is no estate tax, but only for this year.  Remember, however, that Congress and the President can change the law again at any time.

Another important change is in the law regarding the stepped up basis.  (See my October 2009 Estate Planning Insights column about the stepped up basis.  You can find a copy in my blog at www.new.okuralaw.com.)  The usual stepped up basis rules do not apply in 2010, but will again apply starting January 1, 2011.  The 2010 basis rules are called the “Modified Carry-over Basis” rules.  If a person dies in 2010, the tax basis in the property will be the lower of the basis before the person died, or the fair market value at date of death.  However, the executor can increase the basis of assets owned at death up to the lesser of fair market value or 1.3 million dollars, plus up to the lesser of fair market value or 3 million dollars for property passing to a surviving spouse.  To qualify for the increase in basis, the property has to be in the name of the person who dies, or in her revocable living trust.  Although some experts differ on this issue, it is my opinion that property in which a person dies in 2010 with a life estate will not get a step up in basis.

Another important tax change in 2010 is with Roth IRA conversions.  Using a Roth IRA is a wonderful way to invest.  Although you do not get a tax deduction when you put money into the Roth IRA, it grows tax free, and you can take it out tax free.  You do not have to start taking distributions at age 70 ½.  You can leave part or all of it to children or grandchildren, who can take it out over their entire life, totally tax free!  The law has not allowed Roth IRAs for single persons earning more than $110,000 a year or married couples earning more than $160,000 a year.  However, in 2010, regardless of large income, a person may be able to convert a traditional IRA, 401(k) plan, profit sharing plan, 403(b) plan, 457 plan or even an inherited 401(k) into a Roth IRA.  Income tax must be paid on the conversion, and it could be a huge tax, but thereafter the Roth IRA and its profits are tax free forever.  It is possible to set up a Roth IRA to invest in real estate, private corporations and LLC’s, etc. and there are techniques for legally reducing the taxes payable upon conversion.

© OKURA & ASSOCIATES, 2010