Pursuant to the 2001 Tax Act, the Federal estate and generation-skipping transfer (GST) taxes were repealed on January 1, 2010, with reinstatement to pre-2001 Tax Act law beginning in 2011. While practitioners anticipated Congressional action prior to January 1, 2010 to address the repeal/reinstatement conundrum, no comprehensive estate tax reform or short-term fix was enacted.
Estate and GST Tax Reinstatement
Without action by Congress, the estate and GST taxes will be reinstated in 2011, each with a $1 million exemption (compared to a $3.5 million exemption in 2009) and the maximum tax rates will return to 55% (compared to 45% maximum rates in 2009). There is speculation that Congress may reinstate the estate and GST taxes retroactive to January 1, 2010, but there is no guarantee that retroactive reinstatement will occur or if anything will happen soon. A retroactive reinstatement will likely be challenged, although most experts believe that such a challenge is unlikely to prevail. Any challenge would add years of uncertainty for decedents dying in 2010.
The Federal gift tax has not been repealed. In 2010, the maximum tax rate is 35% (compared to 45% for 2009). The cumulative exemption for lifetime gifts is still $1 million, and the gift tax annual exclusion is $13,000 per donee. In 2011, a 55% maximum gift tax rate returns.
Carryover Tax Basis
While the Federal estate tax has been repealed for 2010, a "new" carryover tax basis applies to those who die in 2010 only. The effect is to substitute a capital-gains income tax for the estate tax. Prior to 2010, and beginning again in 2011, assets inherited from a decedent receive a new income tax basis equal to the value of the assets at the decedent's death. Assets inherited from a decedent dying in 2010 do not get a new stepped-up income tax basis, rather, those assets will have an income tax basis equal to the lower of the decedent's tax basis or the fair market value at the decedent's death. There is some relief: every 2010 decedent's estate may increase to fair market value the basis of estate assets by up to $1.3 million, and for assets left to, or in certain cases, left in trust for the benefit of, a surviving spouse, there is an additional $3 million of permitted basis increase.
What should you do?
We recommend that you review your estate planning documents. While it may be tempting to take a "wait and see" approach, a significant percentage of estate plans could be dramatically and adversely impacted by a death in 2010. Many trusts divide assets using tax formulas based upon the Federal estate and GST tax exemptions (both $3.5 million in 2009). For example, in order to reduce estate taxes many married couples have revocable trusts (often called "A-B" trusts) that use tax-based formulas designed to fully utilize the estate tax exemption with the balance to a spousal trust. If the beneficiaries of the various trusts differ (say, the spouse as the sole beneficiary of the marital trust and children as beneficiaries of the family or "credit shelter" trust) the tax-based formulas could, because of tax repeal, dramatically alter your original intent. This unintended result could also "disinherit" children in favor of grandchildren in trusts with generation-skipping provisions. It is possible to avoid these results by amending trusts to take into account repeal, even if temporary, of estate and GST taxes. However, the type and extent of amendments will vary with personal circumstances, and no "one size fits all" amendment is appropriate.
Unfortunately no one knows when, how, or if Congress will act. Prudence suggests action, not delay.