Federal Estate Tax Repeal: How It Affects You

By Insurance.com Posted : 05/17/2007

The federal estate tax (a.k.a. the federal death tax) is a tax that applies to estates worth $1 million or more. Since 2002, the estate tax has gradually been on its way out. Exemption levels are increasing, while the tax rate is decreasing, and by the power of these elements combined, in 2010 the estate tax will be nothing more than a mere memory for a little while at least. Once the federal estate tax is repealed, any inheritance that a heir sells will be subject to capital gain taxes, and the capital gain won't just be taxed on the value gained after the inheritance (like it currently is), but on value gained since the original purchase. These include property, stocks and bonds, which are currently considered capital assets.

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With the new rules, if someone bought a bond for $20, then after you inherited it, its worth rose to $200, and then you sold it for $300-you would be required to pay capital gain taxes on the bond totaling $280. You end up paying taxes on the total amount you gained from the inheritance, minus the original purchase price. With the old rules, you would just pay $100 of capital gain taxes, because while it was in your possession, it grew $100 in worth.

This isn't a permanent feature though. In 2011, the estate tax will be back in action, but the exemption level will drop back down to $1 million or more, while inheritance will once again be taxed at 55 percent. Below is a copy of the Federal Estate Tax Repeal Schedule:

Federal Estate Tax Repeal Schedule
Year Tax Rate Exemption Level
2002 50% $1 million
2003 49% $1 million
2004 48% $1.5 million
2005 47% $1.5 million
2006 46% $2 million
2007 45% $2 million
2008 45% $2 million
2009 45% $3.5 million
2010 Tax Repealed Tax Repealed

Exemption Clause
To make everything more complicated, there is an exemption clause in the tax legislation regarding the federal estate tax repeal. According to financial experts, this "exemption clause" in the capital gains tax could potentially be offset by an exemption of up to $1.3 million per individual, with an additional $3 million exemption for transfers to a spouse. How do you know what qualifies for this exemption? This exemption would work the same as the $20 bond example above, by changing the base value of asset to the current value at the time of inheritance.

Pros and Cons
One of the pros of the law is that long-term planning may become more stabilized. A con is that with the inheritance status change, record keeping and estate planning are going to be even more difficult. With new exemption clauses and spousal transfer issues, the federal estate tax code will be more complicated than it is now.

Should you brace for a big impact?
As long as your financial plan for the coming years is flexible, there is no reason to fret. It's too early to say whether or not you will be affected by the changes in the law, but if buyer's remorse for purchasing a second to die policy is eating away at you, remember this: having alternate life insurance policies will only help you and give your beneficiaries an added cushion when you pass away.

Keep in mind also that although the federal estate tax will be repealed, there will still be a state estate tax in effect. Depending on when you die, the value of your estate, your financial status and the laws that are in effect at that time, it may be beneficial for you to have a survivorship policy or alternate life insurance policy to aid your family in paying off any remaining estate taxes or debt that are not covered.

If the federal estate tax has you concerned, and you want to be sure you have adequate life insurance coverage in the event of your death, or if you are just interested in getting a life insurance quote, log on to Insurance.com. Here you will be able to evaluate multiple rates from best-in-class life insurance providers - helping you find the best life insurance coverage for you and your family.

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