NEW YORK President Barack Obama's tax package passed by the Senate on Wednesday is the gift that keeps on giving.
Well beyond extending the Bush-era tax cuts and a reduced estate tax, it contains a host of provisions that will help wealthy Americans hold on to more of their money.
Notably, the gift tax will stay at 35 percent, its lowest rate since the Depression. Investors can more easily pass assets to grandchildren within a trust this year, and heirs have a better a chance of avoiding capital gains taxes on inherited assets.
Even advisers to the wealthy seem surprised by the generous possibilities contained in the bill.
"There is a mind-boggling amount of money that is going to transfer over the next two years and a mind-boggling amount of revenue that the government is going to miss out on," said Jeremiah Doyle, an estate planning expert at Bank of New York Mellon's wealth management arm.
This year there was no estate tax at all, after Congress failed to replace Bush-era tax policies, but under the new bill heirs can choose to pay it anyway. It may sound like a crazy idea, but it comes with one important sweetener.
The estate tax expired this year but so did a provision that calculated the cost basis of inherited assets at current market prices and not the prices paid years or decades ago by the deceased. If heirs sell the assets straight away, they do not have to pay any capital gains tax.
Without the proposed changes, now pending House approval, heirs in 2010 would be allowed to value only $1.3 million of assets at current market prices, or $4.3 million if assets were bequeathed to a surviving spouse. Inherited assets above these levels would be taxed at the 15 percent capital gains rate when they were sold.
Moreover, heirs faced hefty legal fees as attorneys attempted to figure out the cost basis of individual assets in the estate in order to calculate capital gains.
The current bill says that people who wish to pay an estate tax for 2010 can do so at a 35 percent rate after a $5 million exemption and still apply the unlimited step-up cost basis.
Individuals who inherit less than $5 million should take advantage of this offer, estate planners say. They will not have to pay any estate tax and receive the unlimited step-up basis.
But it is unlikely that heirs of the wealthiest individuals who passed away this year will opt to pay the estate tax. The benefits of resetting asset values with a new basis costs would be outweighed by lower tax rates and higher exemptions.
"You also have to remember that you will only have to pay the capital gains tax if or when you sell an asset, while the estate tax you pay right away," said Jay Waxenberg, chair of the personal planning department at law firm Proskauer Rose.
Next year, the $5 million estate tax exemption will also be able to be transferred between spouses, so if a husband dies first and does not need the full $5 million exemption, the remainder can pass to the wife. When she dies, the heirs will only pay estate tax on any amount above the combined exemption.
This means couples will no longer have to split assets between them and worry about who holds the title over each asset, said Doyle.
Some lucky grandchildren may also receive an extra surprise this holiday season, as the pending bill eliminates a key obstacle to grandparents who want to make substantial gifts.
This year, there was no generation-skipping transfer (GST) tax, a levy designed to stop people from avoiding estate taxes by transferring assets straight to grandchildren.
The GST tax and the estate tax both lapsed this year.
Still, advisers said rich clients were reluctant to transfer assets because it seemed as though assets could only be transferred directly, rather than placed in trust. The fear was distributions from a trust down the road could be taxed.
The new bill clarifies that distributions taken by a grandchild from a trust will not be taxed. Clients are now feeling more comfortable about making the gifts now they can be placed in a trust, said Waxenberg.
Wealthy investors need to act quickly to take advantage, since the GST tax reappears next year. In 2011, grandparents will be able to give $5 million to grandchildren over their lifetime, but anything above that will be taxed at 35 percent.
But if grandparents make the gift this year, they will pay no GST tax and not eat into the $5 million lifetime exemption.
"We're planning for the next couple of weeks to be very busy," said Matthew Brady, head of wealth advisory at Barclays Wealth Americas.
(Editing by Steve Orlofsky)