News & Events
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July 2010
Estate Tax Changes Encourages Action
by Jack S. Johal
As you know, the federal estate tax rules dramatically changed in 2010, and could dramatically change in 2011, unless Congress passes new federal estate tax legislation. This letter summarizes the current status of the federal estate and gift tax.
2001 Tax Act. In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) which provided for significant phased-in increases in the federal estate, gift, and generation skipping tax (GST) exemptions and lower tax rates. EGTRRA provisions included:
- In 2009, the estate and GST exemptions increased to $3.5 million per decedent, with a flat 45% estate and GST tax rate on any excess. The gift tax exemption was $1.0 million, with tax rates from 41% to 45%.
- In 2010, the federal estate and GST taxes were repealed for one year. The gift tax $1.0 million exemption remained, with a lower flat tax rate of 35%. Therefore, you must die or pay gift tax to benefit from the change. The step-up in basis rules (which gave a "fresh-start" fair market basis for most assets of a decedent) was replaced with an adjusted carry-over basis. These new basis rules permit a step-up in basis of up to $1.3 million, plus an additional $3.0 million for certain spousal transfers at death.
- On January 1, 2011, EGTRRA will be automatically repealed, resulting in a $1.0 million federal estate tax exemption and an estate tax rate of up to 60% in 2011.
What Happened in 2009?
Most tax attorneys expected Congress to maintain the 2009 estate tax rules to 2010; however, in December, the House unexpectedly failed to act on a one year extension and instead sent the Senate a bill to make the 2009 rules permanent. Because the Senate was focused on health care and there was broad disagreement in the Senate estate taxes, Congress enacted no changes to EGTRRA's 2010 rules. Thus, there is no federal estate or GST tax effective as of January 1, 2010.
Planning in Chaos
Congress' failure to adopt Federal estate tax legislation in 2009 and the possibility that no legislation will be adopted during 2010, will radically change estate planning considerations. For example, Congress has indicated that in 2010 about 6,000 decedents will benefit from the elimination of estate taxes, but over 70,000 heirs will pay higher income taxes because of the change in the step-up in rules basis.
2010 Changes
Any number of changes may occur in 2010:
- Congress may do nothing in 2010, in which case there is an adjusted carryover basis, and no federal estate or GST tax for people who die in 2010.
- Formula clauses (e.g. terms that allocated your estate exemption to a "by-pass trust") in your planning documents could inadvertently disinherit some heirs and/or your surviving spouse and/or create conflicts among family members on how your documents should be properly interpreted.
- Conflicts could arise among your heirs and fiduciaries on asset basis issues.
- Inadvertent GST taxes could be incurred after 2010.
- Passing assets directly to your surviving spouse may result in higher estate taxes after 2010.
- Congress may adopt legislation to carry the 2009 rules over 2010, retroactive to January 1, 2010. There is broad disagreement on whether a retroactive tax bill would be constitutional. If a retroactive law is adopted, it will be challenged as unconstitutional and it could take years for the U.S. Supreme Court to rule on the issue. Until such a ruling, uncertainty will prevail. Those dying after any enactment should not have that uncertainty.
- If Congress acts in 2010 to address the estate tax issues, it could:
- Adopt a permanent estate tax exemption, beginning in 2010 or 2011. Most commentators anticipate that the federal estate tax exemption will be between $2-5.0 million and tax rates from 35% to 45%.
- Adopt a temporary higher estate exemption.
- Adopt rules to limit or eliminate valuation discounts.
2011 Changes
Unless Congress enacts new legislation in 2010, a number of automatic changes will occur to the federal estate and gift tax law on January 1, 2011, including:
- The estate tax exemption drops to $1.0 million per decedent rather than the 2009 exemption of $3.5 million per decedent.
- The estate tax rate increases (e.g., 55% above $3.0 million and 60% above $10 million).
- The generation-skipping transfer tax will also be effected with the reduced $1.0 million exemption and increased tax rate.
- States which remain "coupled" to the federal estate tax will have their state death taxes restored. If you own property in one of these coupled states, you could have new exposure to a state estate tax.
- The step-up in basis rules are reinstated.
- The top income tax rates go up by at least 4.6%, capital gain tax rates increase to 5% and dividend tax rates increase to 24.6%.
Higher Taxes
No matter what happens to the federal estate tax, substantial tax increases are fairly certain. A $12 trillion deficit is projected for the next decade. The Congressional Budget Office indicates that the social security trust fund will pay out more then it receives starting in 2011 or 2012. Taxes will have to increase across a broad range of Americans. Given the slow economic recovery and the fact that we are in a mid-term election year, taxes will most likely not increase until sometime in 2011. While substantial tax increases are likely, no one knows any details.
Please if you have any additional questions.
