January 2010
Dear Clients and Friends:
Estate tax repeal for 2010 or not? That is the question.
We are sending this letter to explain how your estate plan may be affected by a recent tax law change that came into play on January 1, 2010. On that date the estate tax and generation skipping tax were eliminated for one year.
The zero estate and generation skipping tax for 2010 is a problem and an opportunity. Following are some of our thoughts on the subject.
History
The 2001 tax act increased the estate tax exemption from $1 million to $3.5 million and decreased the top rate for estates, gifts and generation skipping tax from 55% to 45% gradually over the period of 2001 through 2009. The Act provided that in 2010, there is no estate or generation skipping tax and the tax on gifts dropped from 45% to 35% for lifetime gifts of more than $1 million.
If no action is taken by congress to enact an estate tax, the rules and rates are summarized as follows:
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2009
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2010
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2011 (4)
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Estate exemption
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$3.5 million
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No tax
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$1 million
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Estate top tax rate
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45%
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No tax
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55%
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Surcharge if > $10 million (1)
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None
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No tax
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5%
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Basis of assets for heirs (2)
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Date of death
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Modified carryover
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Date of death
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Generation skipping tax rate (3)
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45%
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No tax
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55%
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Gift tax exemption
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$1 million
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$1 million
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$1 million
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Gift tax rate
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45%
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35%
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55%
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- The surtax applies from $10 million to $17 million, so through that range, the rate is actually 60%
- Date of death means that all the pre-death gain is forgiven. The heirs use the date of death value to compute gain or loss on a later sale. Modified carry over means that only $3 million for a spouse or $1.3 million for other heirs of the pre-death gain is forgiven. Otherwise, the heirs use the decedent’s cost basis in the assets to compute gain or loss on a later sale. Yes, coming up with the decedent’s cost in 1972 is going to be a problem.
- The generation skipping tax is an extra tax so the government can make up for the lost estate tax if you leave your property to grandchildren instead of children (it applies to other relationships and non-related heirs as well).
- The 2001 tax act sunsets at 12/31/2010. After that date the law is as it was before the 2001 tax act.
Congressional action (inaction)
Congress (actually the Senate) failed to act before 2010 to change the result. Congress could act now or later this year and have the following options:
- Do nothing so that for 2010 there is no estate tax, and the carryover cost basis rule applies. In 2011 the old rules (pre 2001 act) are restored. See the chart on page one for details.
- Enact a new rule with some amount of exemption at some top tax rate that is fully retroactive to January 1, 2010. The word on the street is that congress is considering an exemption amount of $3.5 to $5.0 million and a top rate of 35% to 45%.
- Same as #2 except retroactive to the date of introduction of the bill (or some other date)
- Same as #2, but elective for deaths after 2009 but before enactment (the executor chooses to pay estate tax with a date of death valuation of assets or no estate tax with a carry over basis of assets).
What to do now (This is not an all inclusive list)
The uncertainty of what Congress will do next and whether an individual will die during this period of uncertainty makes planning difficult. However there are some immediate steps you should take:
1. If you currently have a living trust (or your will includes testamentary trusts), you should have it reviewed. Some items that may need attention include:
a. The formula clauses for trust funding at the first death of a married couple. Many trusts provide that a new trust will be established at the first death which helps to reduce the estate taxes when the second spouse dies. If there is no estate tax that may mean that no funding of the new trust is required. This would be a problem if the beneficiaries of this trust were the children of the decedent and the beneficiaries of the remaining assets are the children of the survivor. Other funding clauses could create similar problems.
b. Funding formulas for the Exempt and Non-Exempt generation skipping trust. If your estate plan calls for different beneficiaries of the Exempt and Non-Exempt trusts, the allocation of assets between them may not be as you originally intended. This could happen because the funding formula is based on the amount of the generation skipping tax exemption and there is no generation skipping tax for 2010 (currently).
c. The 2010 rule for basis of assets in the hands of the beneficiaries is that the executor can increase the carry over basis for up to $3 million for a spouse and $1.3 million for others heirs (as a group) for appreciated estate assets. Does your estate plan allocate sufficient assets to beneficiaries that would allow full use of these increases?
d. Another issue with the increase in basis for some assets is that the executor chooses the assets to receive the increase. Should the executor favor some assets or some beneficiaries? Should the executor try to be even handed in allocating the increases between beneficiaries? You should incorporate your wishes in the trust.
2. If you were planning on making taxable gifts, make them early in 2010. The rate might be 35% instead of 45% or 55% (might because of the potential for retroactive legislation). On the other hand, it is probably not advisable to make gifts you had not otherwise planned to make. You run the risk of paying a higher tax. If you were going to make the gifts anyway, then making them early gives you a chance of a lower tax.
3. For existing generation skipping trusts, can you afford to make distributions to the skipped persons now? If you did, you might avoid the generation skipping tax (might because of the potential for retroactive legislation). Hopefully your trust is written in a way that would allow for the distribution to the skipped persons to be made in trust and not outright if they are young.
4. If you have elderly parents, you should have someone check their wills and living trusts as they may be unaware of the tax law changes or unaware of the hidden dangers.
Closing thoughts
Until congress acts, this is a mess. Since congress failed to act in December, are they likely to act soon or any time before the November elections? If they do enact retroactive legislation, would it be challenged as unconstitutional, making the wait for a Supreme Court ruling and final resolution years instead of months?
You should not act solely on the information provided in this letter. We were brief in our description of laws and situations. We urge you to review your existing estate plan documents now and speak to your estate attorney or to us about your situation. Please call us if you have further questions or if you have other tax, financial planning or accounting questions.
~Your partners in financial success~
~Visit our website at www.morrecpa.com~
