In a 2009 Impact article on estate planning developments, we stated: “As of January 1, 2009, an estate valued up to $3,500,000 is exempt from federal estate tax. Current law provides that the federal estate tax will be repealed in 2010 and be reinstated in 2011 with a $1,000,000 exemption and a higher tax rate. Most commentators believe that the new Congress will not permit the estate tax to be repealed in 2010.” Guess what? The commentators were wrong – 2010 has arrived, and Congress has taken no action.
Under the law as it exists today (February 1, 2010), the federal estate tax does not apply to estates of persons who die in 2010. Unfortunately, however, it is not possible to state with certainty that those estates will not be subject to federal estate tax. The reason for the uncertainty is that Congress may attempt to change the law retroactively to impose estate taxes on the estates of persons who die in 2010. It is widely believed that, as a quick fix, Congress will merely approve an extension of the 2009 estate tax exemptions and rates into 2010. Some analysts believe any attempted retroactive estate tax laws would be unconstitutional; some commentators speculate that Congress will not act at all. A good guess may be that Congress will reinstate the estate tax in 2010, but only after the date of enactment rather than retroactively.
If Congress does not act, the estate tax will be automatically reinstated on January 1, 2011 and, among other things, the exemption will be lower ($1,000,000), and the maximum tax rate will be higher (55%). To confuse things even more, during the period when the estate tax does not apply, the rule on “step-up in basis” to date-of-death values is also inapplicable, and a new “carryover basis” regime must be taken into consideration. Thus, estate tax may not be due, but when the estate assets are sold, they may have a low basis, which will require the payment of income tax on the gain – an amount equal to the difference between the tax basis and the sale price. The new rules allow a limited step-up in basis of $1,300,000 of appreciation for each decedent and an additional step-up of $3,000,000 of appreciation in property passing to a surviving spouse.
Although we have no idea what Congress will do (or when it will do it), there are some actions you may wish to consider. For example, if there is a substantial imbalance in the ownership of appreciated assets, you may wish to consider some reallocation of the ownership in order to manage the impact of the carryover basis rules, should you or your spouse die in 2010.
As another example, if you are married and your estate plan includes transfers upon death to persons in addition to your spouse (for example, children), it is advisable to ensure that the method of defining the amount of such transfers does not cause them to be over-funded. Specifically, if your estate plan was created when the exemption was lower and it calls for the entire exemption amount to be transferred to your children and everything else to your spouse, the increase in the amount of the exemption to $3,500,000 (or possibly higher) may have the effect of over-funding the amount transferred to the children (and under-funding the amount to your spouse). In the extreme case, if there is no estate tax in effect in 2010, all of assets could go to the children and none to the surviving spouse.
If your estate plan includes a joint trust with your spouse for the care of minor children when both of you are deceased, and your plan was based upon the exemption amount being in excess of your combined net worth, then you may wish to change your plan to a more complicated two-trust plan, if the law reduces the exemption amount to $1,000,000 after 2010.
Finally, unless current law is changed, the generation transfer tax on transfers that skip a generation (for example, directly to grandchildren) does not apply in 2010, and the gift tax rate is reduced, so there may be planning opportunities.
There are many potential variations on these themes. It is impossible in a short article such as this to address all of the possible options. By this brief explanation, we hope only to bring these issues to your attention.
Tom Rink is the Chair of the Strauss & Troy Tax Department. If you have questions or concerns, please feel free to contact your Strauss & Troy attorney or Tom Rink (513-629-9490), for a review of your individual situation. Also, consider contacting your Senator or Representative and ask that this confusing situation be clarified immediately.