President-Elect Obama's Proposed Reforms to the Federal Estate Tax

President-elect Obama proposed three items related to federal estate tax reform during the campaign: (i) freezing the federal estate tax exemption amount and top marginal estate tax rate; (ii) creating a “portable” federal estate tax exemption for married individuals; and (iii) continuing the use of fair market value on date of death as the income tax basis for property inherited from a decedent (i.e., so-called “stepped-up” basis).

• Freezing the federal estate tax exemption amount and top marginal estate tax rate.

President-elect Obama has proposed freezing the federal estate tax exemption at the 2009 rate of $3,500,000 per person and freezing the top marginal estate tax rate at the 2009 rate of 45%.

• Creating a “portable” federal estate tax exemption for married individuals.

A portable exemption works as follows: if the estate of the first spouse to die does not use all or a portion of his or her $3,500,000 exemption, the unused exemption would be available for use by the estate of the surviving spouse.  Generally, under a portable exemption, the estate of the surviving spouse may then shelter assets with a fair market value of up to $7,000,000 from the federal estate tax.  President-elect Obama’s advisors have stated that 99.7% of estates would not pay any federal estate tax through a combination of the portable exemption and a freeze of the 2009 estate tax exemption and rate.  Without a portable exemption, a married couple with $7,000,000 of net assets with an estate plan leaving all assets to the surviving spouse would owe no federal estate tax on the death of the first spouse but would owe approximately $1,575,800 of federal estate tax on the death of the second spouse.  With a portable exemption the federal estate tax could be zero in this example.

• Continuing fair market value tax basis for property.

President-elect Obama has proposed continuing the use of the fair market value on date of death as the income tax basis for most inherited property.  The notion of fair market value on date of death as the income tax basis for inherited property is known as the “basis step-up” or “stepped-up basis” assuming the inherited property has increased in value from the date of acquisition to the date of death.  Under current law, property inherited from a decedent receives an income tax basis equal to the fair market value of the property at the date of the decedent’s death (or, in some instances, the fair market value six months after the date of the decedent’s death).  For example, if a decedent purchased stock in 1990 for $100,000 and the stock is worth $1,000,000 on the date of the decedent’s death, the person inheriting the stock receives a tax basis in the stock of $1,000,000.  The subsequent sale of the stock by the beneficiary for $1,000,000 would not result in any taxable gain.  Under current law, the basis of property received from decedent’s dying after December 31, 2009, may not receive a fair market value basis.  As a result, in the above example, the beneficiary receiving the stock worth $1,000,000 purchased in 1990 for $100,000, would realize $900,000 in taxable gain.