• It's a Fine Mess Congress Has Gotten Us Into (With apologies to Laurel and Hardy)
  • January 11, 2010 | Authors: Robert E. Bennett; Jon J. Gallo; Arnold D. Kahn; Marc M. Stern; Laura A. Zwicker
  • Law Firm: Greenberg Glusker Fields Claman & Machtinger LLP - Los Angeles Office
  • For the first time since 1916, the U.S. no longer has an estate tax, or does it?

    Back in 2001, Congress enacted a ten year plan designed to eliminate the estate and generation skipping transfer (GST) taxes. . . kind of.  The 2001 law phased out both the estate tax and GST tax over nine years by gradually decreasing the tax rates from 60% to 45%, increasing the exemptions from $1 million to $3.5 million, and, providing for complete repeal of both taxes for individuals dying and transfers occurring in 2010.  But the “repeal” is hardly complete, it is scheduled to last for only one year and does not affect the gift tax, except to reduce the gift tax rate.

    Following one year of repeal, the estate and GST taxes are scheduled to be restored in 2011.  They are not only restored, but they are restored with a maximum tax rate of 60%, a maximum estate tax exemption of only $1 million and a maximum GST exemption of approximately $1.35 million!

    Most estate planners had believed that Congress would never allow this repeal/resurrection scenario to take place.  Sure enough, starting in 2009, several bills were introduced in Congress to address this issue.  Late last year, the House passed a bill that would have permanently extended the taxes at the 2009 level, but the Senate refused to bring the issue to a vote.

    Democratic members of the Senate Finance Committee have vowed to pass a bill early this year that would repeal the repeal of the estate and GST taxes.  In fact, they want to retroactively reinstitute both taxes as of January 1, 2010!

    So what is the current situation?  There is no estate tax for individuals dying in 2010 or GST tax for transfers occurring this year.  The gift tax is still in effect with an exemption of $1 million, but with a reduced maximum rate of 35%.  However, beneficiaries of individuals who die in 2010 no longer receive property with a new income tax basis equal to fair market value at the date of death.  Instead, subject to certain adjustments, the beneficiaries will use the decedent's basis.  (This concept ¿ known as carry over basis ¿ was actually made into law about thirty years ago but shortly thereafter repealed as unworkable.  Exactly why Congress assumes that carry over basis works in 2010 is impossible to explain.)

    The effect of these developments on existing estate plans is a complex question.  For example, a married couple's estate plan which utilizes a "Credit Trust" (also sometimes referred to as a "Bypass Trust") to minimize transfer taxes on the deaths of both spouses may need to be revisited.  Under the laws now in effect, if a spouse dies with an estate plan that creates a Credit Trust funded with the "maximum amount that can pass tax free" (as many estate plans are currently drafted), the spouse's entire estate would pass to the Credit Trust.  Depending on its terms, the Credit Trust may not provide adequate support for the surviving spouse.  Because the GST tax has also been repealed, an estate plan that leaves "the maximum amount that can pass free of the GST tax" to grandchildren could result in inadvertently disinheriting children.  On the other hand, the uncertainty surrounding the future of the estate and GST tax and the reduction of the maximum tax rates to 35% may offer unique planning opportunities to transfer wealth in a tax efficient environment.

    Of course, Congress may act to reinstate the estate and GST taxes this year.  If Congress does act, it is unknown whether the provisions in effect in 2009 will be reinstated or new provisions will be adopted; it is also not known whether the provisions will apply retroactively.