The One-Year "Repeal" of the Federal Estate Tax

The unthinkable has happened. At the end of 2009, Congress failed to reach a compromise on extending the federal estate tax and the generation-skipping transfer (GST) tax. The result is that these taxes are “repealed” for one year, and the gift tax, while still in place, is reduced for one year. Here is a quick summary of the 2010 tax situation, subject to the warning that Congress could still make changes that would be effective retroactively:

• Estate tax. There is no federal estate tax for people dying in 2010. (In 2009 there was a 45% tax rate after a $3.5 million exemption.)
• GST tax. There is no GST tax in 2010 on generation-skipping transfers, such as gifts to grandchildren or distributions from trusts to grandchildren of the donor. (In 2009 each individual had a $3.5 million exemption and only certain trusts were exempt.)
• Gift tax. The federal gift tax is still in effect for 2010, but the rate has been reduced to 35%. The exemption remains at $1 million. (In 2009 the top rate was 45% and the exemption was $1 million.)

Unless Congress makes changes, both the estate and GST taxes come back with a vengeance in 2011, with a $1 million estate and GST tax exemption (with the GST tax exemption indexed for inflation) and top estate, gift and GST tax rates of 55%.

Estate Plan Review

If you die while there is no estate tax in effect, assets could pass under your will or trust in ways that you did not intend -- and do not want.

Some documents contain formulas that change the allocation of property between the recipients dramatically if there is no federal estate tax or GST tax, and those dramatic changes may not be consistent with your intentions.

Allocation of assets between spouses may also need to be reviewed in light of the one-year repeal of the automatic “step-up” of tax basis on death and the substitution of “carryover” basis rules.

If you have any doubts or questions about your estate plan, you should contact us to schedule a review. You may be due for one anyway as we generally recommend a review every three to five years, or sooner if there are changes in family or financial circumstances.

There are especially strong reasons to call us if:

• You are married and have children from a prior marriage
• You make charitable bequests in your estate plan that are expressed using percentages or formulas
• Your plan allocates property based on the amount that can pass free of GST tax
  • For example, a formula which, for a death in 2009, would have resulted in allocation of $3.5 million to a trust for grandchildren, may, during temporary tax repeal, result in allocation of the entire estate to the trust for grandchildren
• You live in a state such as Florida or New Hampshire which has no state estate tax
• Your estate plan has not been reviewed in the last three years

Gifting Opportunities

The current “repeal” year presents some estate planning opportunities. However, given the current uncertain environment you should be sure to consult closely with your estate planning attorney before taking action:

• This may be a good time to make gifts in excess of the $1 million gift tax exemption. If the current 35% gift tax rate is not changed back to 45% retroactively, this may be a one-time opportunity to make transfers at a relatively low tax rate
• This may be a good time to make transfers to grandchildren or further generations from irrevocable trusts that would otherwise be subject to GST

The current economic environment also may present excellent gifting opportunities. Some of the positive factors are:

• Historically low values for many types of assets, including residences, vacation homes, publicly traded stock, private companies, commercial real estate and alternative investments
• Extremely low interest rates

Many of our clients have successfully used the current environment to make low- or no-cost gifts to family members, other beneficiaries and trusts, and to make tax-advantaged gifts to charities as well.

Conclusion

2010 is the most challenging year for estate planning in at least the last 60 years! We would be glad to help you sort out the implications of the topics discussed above. It is important to keep in mind that, at least under current law, the federal estate tax is scheduled to be reinstated starting January 1, 2011. In this case, most problems of interpretation would vanish, although taxes would also increase. It is also possible, and perhaps likely, that Congress will reach a compromise and will re-enact a federal estate tax to be effective at some point during 2010. As a result, each client must consider his or her own situation to determine whether the costs of revising an estate plan outweigh the potential benefits.