BusinessReport.com

Death and taxes might be the only sure things in life, but some taxes due after death are no longer applicable. The estate tax expired last year without a renewal by Congress, effectively vanishing in 2010.

Macabre jokes about bumping off grandma aside, the issue has raised serious questions for estate planners trying to help clients get their affairs in order—whether death is anticipated just around the corner or more distantly.

“This whole area of estate planning is in a state of flux,” Bill Pomeroy, executive vice president of The Shobe Financial Group, says. “Nobody knows what’s going to happen. There are several complicating factors that can impact the estate tax. The bottom line is, we don’t know.”

The traditional situation went something like this: The 2009 tax—starting at 45%—applied to estates $3.5 million or more with the assets valued at their worth upon the owner’s death; clients made use of several different methods to distribute their assets, including trusts and a life insurance policy dedicated to paying the tax, so heirs could inherit the bulk of the estate free and clear.

Now the estate tax is gone, and with it, the step up for evaluating assets. That means heirs could be responsible for capital gains taxes on all assets based on their appreciation from the time of acquisition. For example, a house worth $2.5 million that was worth $500,000 when the owner bought it 20 years ago would have a long-term capital gain of $2 million. But that amount does not account for any improvements or additions to the house over the term of ownership, so those inherent capital gains would have to be calculated to come up with a final figure to be taxed.

There is an exemption in place for the first $1.3 million in capital gains for heirs and $3 million for a spouse. A conscious saver and investor could put that amount away in a stock portfolio and real estate over a lifetime. The upshot is that capital gains could be levied on people who might have been exempt from the expired estate tax.

“Depending on how you classify assets, who inherits what will dramatically change in 2010 the impact of taxes on the estate,” says Lance Paddock, chief executive officer of Thompson Creek Wealth Advisors. “This means that some strategies that tended to move more away from the spouse and, with use of trusts, onto the side of the heirs, do not make sense—but only for this year.”

If the bulk of an estate is in retirement accounts, such as an IRA, those funds will also be subject to an income tax. While that does not necessarily spell disaster for heirs, it does mean that potentially 70% of an estate is taxable when it would have been exempt under the old law.

The expiration of the estate tax might also decrease the amount of charitable giving and lifetime gifts, two ways of traditionally reducing the size of an estate. However, that scenario might be avoided if Congress votes to renew the tax at a later date. Moreover, most donations also come from charitable impulses, says Hugo Marrero Jr., president of Marrero Wealth Management.

“So far, with the exception of gifting to the family, people who are gifting to charities are doing so for reasons other than just estate planning,” he says. “Those philanthropies will probably continue to happen.”

Congress could choose to renew the estate tax at a higher rate with fewer exemptions for 2011 and make it retroactive to Jan. 1, 2010. That means applicable estates would be subject to an estate tax even after paying capital gains taxes—and even more of a headache for heirs, the IRS and, most probably, the courts. There is legal precedent for making estate taxes retroactive. Whether or not Congress has the constitutional right to levy a tax in 2011 for the previous year is not an issue likely to be decided in the policy books.

Estate taxes are also politically charged; conservatives generally dislike the concept. And as the balance of power shifts in the Senate, it is difficult to gauge exactly what measure, if any, will be passed. The sticking point is that there is no way to know when or if Congress will address the issue. While most agree some measure will be put into place, estate taxes are not thought to be high on the legislative body’s agenda.

“Right now, it’s a very big problem with a very low priority,” Pomeroy says. “Health care and the economy and the recession … I could name a dozen other things, but this is getting more and more important, and they don’t have time for it.”

The entire debate puts estate planners in a bind: How do you advise a client when there is no way to predict how the tax laws will change? Pomeroy has two words: contingency planning—whether the law remains at the pre-estate tax level, changes or even remains in limbo. Meeting with an estate tax attorney would help a client generate more than one strategy to deal with a shifting tax code, but the main focus should be on mitigating risk now and in the long term.

“I have to plan that you don’t make it home today,” Marrero says. “I have to plan that in 10 years, you are going to have things you yourself don’t realize yet and I can only see through my other clients who have been down that road. Then we have to plan for retirement.”

So can 2010 be considered a good year to die? In terms of passing money along to heirs, yes. The financial ledgers speak for themselves, but whether or not the lack of an estate tax will come back later to haunt them is anybody’s guess.

“That’s not exactly the kind of advice clients want to hear,” Paddock says. “It’s good for their heirs, but it’s not good for them, so I’m not handing that piece of advice out.”