This year’s temporary repeal of the Federal Estate Tax has created a new set of problems for those inheriting appreciated assets.  Amy Feldman details these problems in her article “Trouble For Heirs” found in the April 25, 2010 issue of Bloomberg Businessweek.  There is no Federal Estate Tax in 2010, but stepped-up basis of assets is limited to:

1.  $1.3 Million of assets determined at date of death.

2.  An additional $3 million for the surviving spouse.

3.  Basis allocation based on the Executor’s discretion.

In addition, there exists the practical problem of finding all the records to determine the basis especially where dividends have been reinvested or improvements have been made to real property.  How many people have all those records that could go back 50 to 60 years or more.

Maryland heirs’ situation is further complicated by the State’s Estate Tax of up to 16% on amounts exceeding $1 million.  The Maryland Legislature did pass emergency legislation to protect the bypass exemption to the December 31, 2009 amount of $3.5 million.  The legislation solves one of the problems that Amy Feldman mentions in her companion article “Wills That Won’t”.  However, for most families putting up to $3.5 million in a bypass trust leaves nothing to pass outright to the surviving spouse creating even more unintended consequences.

Families with wills or trusts that contain bypass provisions should schedule an appointment with their attorney to review their documents.  Changes may be needed to comply with the 2010 Estate Tax Laws.  Most Estate Tax Lawyers predicted that Congress would act to extend the Federal Estate Tax at least by early 2010.  It is now May 2010 and time for astute families to act to ensure their legacy is protected.

In 2010 the income limitation for converting traditional IRA to a Roth IRA will be eliminated. Furthermore, one half of the conversion income can be reported in 2011 and the final one half of conversion income can be reported in 2012. Whether paying the tax for future tax free withdrawals depends on many factors, but primarily on what tax rates will be when the money is withdrawn. That is a calculation you need to consult your tax and financial advisor on to determine its suitability for financial goals. From an estate planning technique the conversion to Roth reduces your total estate, but provides the same amount of future income by essentially prepaying income taxes. If your IRA gets stretched out over a long period of time as younger beneficiaries inherit the funds, the benefit of the conversion increases.

Many of you have seen your estate values cut in half or more while the Federal Estate tax minimum has gone from $2 million to $3.5 million. The feeling is that you do not need to do any estate planning. The problem is that you do not know what the law will be at the time when you pass away. Moreover, the law is even more likely to change by the time the second spouse dies.

As an example, we frequently see widows that have outlived their husbands by ten, twenty, or even thirty years. When their husbands passed away the value of his estate was often less than the federal limit at that time of $675,000. The surviving wife ended up with home, investments, and a pension. The pension and social security covered all her living expenses. The home and investments continued to double every seven to nine years depending on the market conditions. The widow continues to hold the investments concerned that she may need the money in the event of a serious illness. More than likely, the state of Maryland will receive 16% of the amount the estate exceeds $1 million dollars or the estate will be devoured by medical expenses.

This scenario could easily repeat itself if assets return to their historic values. Establishing a By-pass trust upon the death of the husband would have protected the couple’s moderately valued estate for their children by effectively doubly the estate tax exemption. Long care health insurance provides protection for the expense of nursing care.