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Uncertainty Surrounds Estate Tax Law in 2010
January 27, 2010
Congress failed to pass estate tax legislation prior to Dec. 31, 2009 and, as a result, the United States is without an estate tax for the first time in almost a century. The estate tax was to expire for one year in 2010 under the Economic Growth and Tax Reconciliation Act of 2001 and then revert to pre-2001 levels. However, the gift tax remains in place with a $1 million exemption and a 35% maximum rate for 2010.
Most planners believed that permanent estate tax reform, or at least a one year patch, would be passed prior to year end. However, despite predictions to the contrary, one year of zero estate tax is here.
As 2010 has begun, the prospects for estate tax legislation are uncertain. If Congress passes legislation later in the year and attempts to make the legislation retroactive to January 1st, we will likely see a string of lawsuits challenging the constitutionality of such retroactivity.
Current estate plans are significantly affected by the current state of the estate tax law. Typical trust documents and wills do not account for an environment with no estate tax. Often, wills or living trusts contain language that divides a decedent’s property into a “family” trust and a marital trust (or an outright bequest to a spouse). The portion going to the family trust is generally the maximum amount that can pass free of federal estate tax with the balance of the decedent’s assets passing to the marital trust or spouse.
Because of this change, a death in 2010 may cause the unintentional over-funding of the family trust by directing all assets to the family trust and the under-funding of the marital trust/spousal amount. While many family trusts have the surviving spouse as a beneficiary, having the spouse’s funds in trust may not have been the intention of the estate plan. You should, therefore, review your estate documents with your tax advisor and attorney as soon as possible to ensure that your intentions will be carried out regardless of the changes in the estate tax law.
Another significant consequence of estate tax repeal for 2010 is carryover basis. Traditionally, inherited property has a new tax basis equal to fair market value on the date of death. This basis adjustment prevented capital gains tax if the beneficiary sold the property. However, effective January 1, 2010, the basis of inherited property is the lesser of fair market value at the date of death or the decedent’s basis in the property. The result is that we now generally have carryover basis.
As usual, there are some exceptions to the carryover basis rules. The 2010 law provides for a $1.3 million step-up in basis for non-spouse transfers and a $3 million basis step-up for transfers to a surviving spouse. Even with these step-up provisions, far more taxpayers will be affected by capital gains taxes than would have been with 2009 law. If the estate tax is retroactively reinstated, then modified carryover basis should not be a concern. However, if your estate contains low-basis assets, you should consult with your tax advisor about strategies that minimize the overall tax impact related to these assets.
In this uncertain estate tax environment, it is crucial to be proactive with your estate plan and make sure you are taking advantage of favorable estate planning techniques.
In order to plan for the changes discussed here and to make sure your estate is poised for future estate tax legislation in 2010, we encourage you to contact your tax advisor.
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