Q: I am confused. I thought that death taxes were abolished. Now I am hearing that Congress wants to make the abolishment permanent. And my CPA is saying that all of this is just smoke and mirrors because while everyone is focused on death taxes, Congress has hit us with new taxes. What is right?

A: All of the above. But first a little background. The following "facts" come from a variety of sources but I will just repeat material from a recent TV program on Wall Street Week.

Death taxes, in one form or another, have been around for 89 years and raise about eighteen billion dollars of revenue each year. However, only 2% of the American public will eventually be subject to this levy and then for only part of their assets. So why at this time in our history does close to 70% of the population want to eliminate death taxes? That could be the subject for another column but for me a significant statistic is that 40% of us expect to have to pay death taxes (i.e., we will be included in that 2%).

So what is this death tax? If a corresponding amount is not received in return, a federal tax is imposed on a transfer of wealth whether as a gift or an inheritance at death. There are a number of exceptions to the rule concerning taxing transfers.

First one spouse can leave any amount tax-free to a surviving spouse. A second major exception is that this year one person can pass on at death $1,500,000 tax-free. Under the current law, the amount will increase to $2,000,000 in 2006, $3,500,000 in 2009, an unlimited amount in 2010, and then $1,000,000 (some experts say only $700,000) in 2011. So the death tax has been and maintained (in 2007, 2008, and 2009), eliminated (in 2010), and reappears in 2011.

For the last four years the House of Representatives has voted to eliminate the reintroduction of the death tax after 2010. The Senate has for three years said no and is expected to do so again. But at some point, the federal tax threshold could be permanently set at a figure such as $2,000,000, or $3,000,000, or $4,000,000. Few expect estate taxes to be eliminated.

As your CPA points out, this also can be considered political smoke and mirrors. Any estate-planning attorney worth his or her salt can eliminate death taxes for a family, even for billionaires. So is this all much to do about nothing? No, if a revenue source that is expected to produce about $140 billion over the next ten years is involved. Thus, while the public has been focused on the politiciansÕ death tax hand, like good political "magicians" new tax exposure has been imposed with the other hand without much discussion regardless of the death tax outcome. How? Two eliminated features of the old law will not come back in 2011, unless inserted in any Senate-House conference committee meetings.

First, in the past because assets were subjected to possible death taxes, the beneficiaries of the estate receiving the assets would obtain a stepped-up basis on the asset from what the deceased paid to what an asset was worth at the date of death, thus eliminating the amount of the lifetime appreciation from capital gains. The new law (for our simplified review) for the most part carries over the deceasedÕs basis to the heirs. Thus instead of 2% having to pay taxes because of transfers at death, anyone inheriting an appreciated asset will have to pay extra capital gains when the asset is sold, thus in effect causing a stealth death tax transfer. So death tax consequences have expanded from 2% of us to many, many more, even in very small estates if appreciated assets are involved. And where as tax planning can eliminate the old death taxes, it is almost impossible to eliminate capital gains on most kinds of assets. And with one exception, even with real estate, paying capital gains taxes can be postponed by using a 1031 exchange but not eliminated.

Finally, under the old estate tax law, gifts and death transfers were tied together. That is, part or all of the death tax exclusion could be used partly or totally for gifts and what remains to minimize death taxes. Now only $1,000,000 can be used for sheltering gifts from taxes. For any lifetime transfer where the cumulative total exceeds $1,000,000, the tax is imposed.

But beware. Even if federal death taxes are eliminated, the individual states can step up to the plate and either keep, impose, or increase state death taxes. Eighteen billion dollars in revenue could be an attractive revenue source.

Thus, where are we? After all of this, death taxes are slated to come back. But even if they do not, we are now faced with death transfers affecting many, many more people through capital gains exposure, a cap on tax-free gifts, and the prospect of states stepping up and mining this "new" revenue source that the federal government has "abandoned."