Written by Chris Cooper, CFP®
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February 15 2010
Nine years ago, Congress passed the Economic Growth Tax Relief and Reconciliation Act of 2001 (EGTRRA), which made major changes to the federal estate tax system. The 2001 legislation progressively increased the federal estate tax exemption from $1 million to $3.5 million and lowered the overall estate tax rates between 2002 and 2009. EGTRRA also provided that the federal estate tax would be completely repealed during the year 2010, and would revert to pre-2001 law beginning in the year 2011.
Until December 2009, most estate planning and tax professionals believed that Congress would change the law before 2010 to avoid a complete repeal of the tax for one year. However, Congress failed to act, and as of January 1, 2010, the federal estate tax is not applicable. Additionally, the generation-skipping transfer (GST) tax is not in effect during 2010. The gift tax exemption remains at $1 million, but the tax rate on 2010 gifts is 35% (a 10% reduction from 2009). The annual exclusion from gift tax remains at $13,000 per donee during 2010. Next year, in 2011, the estate and gift tax exemption reverts to $1 million, and the GST tax will be reinstated (with a $1 million exemption).
EGTRRA also mandated carryover cost basis for property inherited from a decedent who dies in 2010. Historically, federal income tax law has allowed taxpayers to "step up" the basis of inherited assets to the value of such assets on the date of death. However, under this year’s carryover basis regime, inherited property will maintain its original basis, subject to two limited basis allocation rules.
The above changes will significantly affect the estate plans of some individuals. Many estate planning documents are drafted by formula to create two trusts when a married individual passes away—a family trust to hold assets equivalent to the estate tax exemption amount and a marital trust for all other assets. Often, the beneficiaries of the marital and family trusts are the same individuals, but when they are not, the elimination of the federal estate tax undermines this trust planning. Without an estate tax exemption amount, marital trusts will not be created, and certain beneficiaries (primarily a surviving spouse) may be inadvertently disinherited Other formula-driven trust or will provisions may also be affected (e.g., a provision that distributes the amount exempt from estate taxes to non-charitable beneficiaries and the balance of the estate to charities).
While the lack of legislation creates challenges, it may provide opportunities for certain multi-generational planning strategies. There are other changes to the tax laws being considered that, if passed, will restrict, place limits on, or eliminate certain estate planning techniques available today. Individuals desiring to maximize the transfer of wealth should consider taking action now.
We are hopeful that Congress will act swiftly to resolve this tax conundrum. Some experts believe Congress will propose tax legislation that will be retroactive to January 1, 2010; others believe that such legislation—if passed—will be unconstitutional. Congress has offered little indication of its plans for the estate tax this year, but we will be monitoring any proposed and/or enacted legislation. In the meantime, all estate planning documents should be reviewed to ensure that they continue to meet the individual’s objectives during this uncertain planning environment.
