As you may already know, the federal estate tax rules changed drastically in 2010, and could change radically again in 2011. We want to advise you of what has happened and encourage you to review and re-evaluate your estate plan as soon as possible.
Congress passed legislation in 2001 that had the following results:
• The federal estate and generation-skipping taxes were repealed for one year commencing on January 1, 2010. The gift tax remains in effect with a $1.0 million lifetime exemption and a top gift tax rate of 35%.
• The step-up in basis rules (which gave a "fresh-start" fair market tax basis for most assets inherited from a decedent) were replaced with adjusted carry-over basis rules. These new basis rules permit a step-up in basis of up to $1.3 million for assets inherited by all heirs and an additional $3.0 million for assets bequeathed to a spouse.
o Property that does not receive this allocated step-up in basis will be subject to tax on its subsequent disposition by an heir based upon the increase in value over the carry-over tax basis.
o Not surprisingly, these new basis rules are convoluted. In fact, Congress attempted to institute a similar carry-over regime in the 1980s and it was repealed retroactively, because it was too difficult to administer.
Without the passage of new legislation on January 1, 2011, a number of automatic changes occur to the federal tax code, including:
• The estate tax exemption drops to $1.0 million per decedent (from $3.5 million
• The estate tax rate increases (e.g., 55% above $3.0 million and 60% above $10 million).
• States such as Michigan and Florida that remain "coupled" to the federal estate tax will have their state death taxes restored. Thus, if you own property in one of these coupled states, you could have new exposure to a state estate tax.
• The fair market value step-up in basis returns for assets passing from a decedent.
Because of the failure of Congress to act up to this point, we are now in a planning environment in which any number of radically different changes may occur in 2010. While the consensus among estate planners is that Congress will pass new legislation this year which will reenact the federal estate and generation skipping taxes, there is no certainty when and if that will occur. While it is possible that Congress will reenact these taxes retroactively to January 1, 2010, there is uncertainty whether such a retroactive reenactment will be determined to be constitutional. However, it is also possible that Congress may do nothing in 2010, in which case the situation will remain as described above
As we have communicated to our clients in the past, it is a good idea to review your estate planning documents every few years for changes in the law, family situations, assets, business circumstances, and other changed facts and circumstances
We suggest that you now need to review and reconsider your estate plans keeping in mind the following issues, among others, when you do your review:
• For married couples, as well as single individuals, you need to first make sure that your property will be divided and distributed according to your desires, and not as dictated by Congress. For more than 50 years it has been common to use a written “formula” to divide the assets of a married couple when the first spouse dies to maximize estate tax savings. Likewise formulas have been used to provide funds for charitable causes and to benefit family and friends. Now, in 2010 when there is no estate tax, these formulas may not work. If a spouse is not your sole beneficiary (for example, if you have children from a prior marriage), the existing formula could result in the disinheritance or substantial reduction of resources provided for the surviving spouse.
• Be aware that as a result of the carry-over basis rules, conflicts could arise among your heirs and fiduciaries on the allocation of the limited step-up in basis that has been built into the current structure.
• Inadvertent generation-skipping taxes could be incurred after 2010.
• If a death occurs in 2010, passing assets directly to your surviving spouse may result in higher estate taxes upon his or her death after 2010.
Finally for some of you, there is an income tax planning opportunity that might be considered this year. During 2010, taxpayers can convert traditional IRAs to ROTH IRAs and can pay the income taxes due on such conversion in 2010 or equally in 2011 and 2012. There are significant benefits and traps for the unwary in making these decisions. Thus, you may want to review this opportunity with us and your other advisors.
We look forward to hearing from you.
BENSON J. BARR
HOWARD J. GOURWITZ