FEDERAL ESTATE TAX UPDATE

For eight years, since almost immediately after the last major change to the federal estate tax in 2001, we have been talking about the scheduled repeal of the federal estate and generation-skipping transfer taxes in 2010 - and the reintroduction of those taxes in 2011 (at the lower exemptions and higher rates under the prior law). Now that we are on the eve of 2010, will repeal happen? The answer, as of mid-December, is a resounding probably not.

A variety of bills have been introduced in both the Senate and the House of Representatives that all extend the estate tax in one form or another. The House passed a bill (H.R. 4154) on December 3 that would make permanent the 2009 estate tax exemption of $3,500,000 and the top tax rate of 45%. We understand that the Senate is unlikely to pass this bill as currently written, and so there is no clear path to enactment. However, the combination of tax policy supporting an estate tax and budgetary concerns driven by the current economic crisis has made the prospect for repeal extremely unlikely.

Our sense of the current debate is that the issue is not whether to extend the estate tax but how. Should it be simply a one-year extension of the current law, with decisions on a more significant overhaul to be deferred until next year in conjunction with major tax reform? Or should a more permanent resolution of the estate tax be enacted now, as provided in H.R. 4154? Among the proposals being put forth are the following:

  1. increasing the exemption and decreasing the tax rate, either immediately or phased in over several years,
  2. reunifying the estate and gift taxes, which could mean the lifetime gift exemption could increase to $3,500,000 or more, and
  3. introducing the "portability" of the federal exemption amount, which could allow a surviving spouse to take advantage of the first-to-die's unused federal estate tax exemption.

What does this mean for you? Aside from the continuing uncertainty, it depends on your particular circumstances and your existing estate plan. Most estate plans for married couples provide flexibility to take advantage of the available federal tax exemptions, regardless of their amount. The more significant recent estate tax law change for married couples has been the "decoupling" of state estate tax laws since 2001, which could necessitate a change to your planning documents to minimize state estate tax due at the first death, if you have not already done so. A reunification of the estate and gift tax laws, however, might present a significant planning opportunity for clients interested in transferring wealth to their descendants during their lifetimes. We will continue to monitor events in Washington, and we will provide a summary of the legislation when it is finally signed into law, probably just before the end of the year or possibly in early 2010.

PLANNING FOR THE REMAINDER OF 2009 AND THE BEGINNING OF 2010

It is not too late to take advantage of estate planning and gifting opportunities for 2009. It is also a great time to start thinking about 2010!

Year-End Gifts.

For many, the end of the year means gifts. If your financial situation permits, making use of what is called an "annual exclusion gift" is a good way to help a child, grandchild or other loved one now and to reduce your taxable estate at death. In 2009, you may give up to $13,000 to each individual donee. Such gifts may be made outright to the donee or to a trust for the donee's benefit (so long as the trust meets certain criteria). The trust can be used to provide for education expenses or to help the beneficiary buy a home or to provide a financial cushion or for almost any purpose you wish. If a qualifying trust is already in place, the gift can be made directly to the trustee to increase the amount already held in trust. Regardless of how many people receive annual exclusion gifts from you, there is no reduction in the amount of your federal estate tax exemption available at your death and no need to file a gift tax return. A husband and wife can each make separate $13,000 gifts to a donee in 2009.

If you are interested in funding a Section 529 plan for college expenses for a child or grandchild, you may contribute up to $65,000 for each beneficiary in 2009. You can elect on your gift tax return to make advance use of your 2010 through 2013 annual exclusion gifts to that beneficiary and you may not make any additional gifts to that person for five years unless the annual exclusion amount increases or you are willing to use some of your lifetime gift tax exemption (currently $1,000,000).

Usually, a United States citizen can make unlimited outright gifts to his or her spouse, but if your spouse is not a U.S. citizen, the current annual gift amount is limited to $133,000. Depending on the circumstances, taking advantage of this annual gift could be beneficial to reduce the amount of the donor spouse's estate and to increase the amount that the donee, non-citizen spouse can shelter from estate tax.

Now is also a good time to start planning for gifts in 2010. The annual exclusion amount will remain at $13,000 per donee. The equivalent annual exclusion amount for gifts to a non-citizen spouse will increase to $134,000. If you think a trust for a beneficiary is appropriate, consider setting up one now and making the 2009 and 2010 gifts in quick succession so that the trust has adequate funds to allow diversification in investments.  

Click here to view table.

IRA Minimum Distributions and Roth IRAs.

No required minimum distribution from an IRA account is needed for 2009 because Congress waived that requirement this year. However, the end of the year is a good time to verify that the beneficiary designation for any IRA, 401(k) or 403(b) account is consistent with the design of your estate plan. With so many recent mergers and changes of ownership at financial institutions, it is especially appropriate if you have accounts at such an institution to verify that the appropriate beneficiary designation is on file. If you are not sure as to the appropriate designation, please call us.

2010 will mark a significant change in the law for those with IRA accounts in their own names (as opposed to those with inherited IRA accounts) because some or all of that IRA account can be converted to a Roth IRA account regardless of the owner's other income. In 2009, if the owner has more than $100,000 of other income, it is not possible to convert to a Roth IRA. When you convert a traditional IRA account to a Roth IRA account you will have taxable income on all of the IRA that has not been previously subject to income tax. For the year 2010 only, the conversion income is treated one-half as 2011 income and one-half as 2012 income unless you elect to include it as 2010 income.

The advantages of a Roth IRA include:

  1. all future growth is income tax free, and
  2. the Roth IRA owner (as opposed to the beneficiary) is not required to take annual distributions from the account regardless of age.

Who should consider such a conversion? From a long-term perspective, generally if you meet all of these criteria you are an excellent candidate:

  1. you have funds outside of the IRA to pay the income taxes;
  2. you do not expect the conversion income to put you into a higher tax bracket than you would be in when you (or your beneficiaries) otherwise withdraw the funds;
  3. you do not need distributions from the Roth for living expenses; and
  4. those you name as beneficiaries are willing to take advantage of the stretch out opportunities a Roth IRA offers.

Even if you do not satisfy all of the criteria, especially if your estate will likely exceed the federal exemption limit (currently $3,500,000), it may make sense to convert some or all of an IRA account to a Roth. Further, there are certain short-term income tax considerations that may encourage you to make a conversion because you have to pay little or no additional income taxes to do so. Two examples are if you have expiring net operating losses or excess charitable deductions. Consult your financial advisor or us for a more detailed review. A consultation is especially important if you plan to convert a sizeable dollar amount to a Roth IRA because some conversion approaches provide more flexibility.

PET TRUST LEGISLATION IN CONNECTICUT, NEW YORK, NEW JERSEY, AND MASSACHUSETTS

Under traditional rules of trust and estate law, animals were considered a form of property and could not be legal beneficiaries of a trust. As the United States became an increasingly pet-devoted nation (the American Pet Products Association estimates that Americans own 75 million dogs and 88 million cats), the notion of pets as property carried less weight. Today, forty-three states have enacted legislation specifically authorizing the creation of trusts for the benefit of domestic animals. In 2009, Connecticut became one of the most recent states to adopt a so-called "pet trust" statute. In acknowledgment of Connecticut's new law, we have provided a summary of the pet trust statutes in the states in which we practice.

connecticut

As of October 1, 2009, Connecticut residents can create legally enforceable pet trusts for the benefit of one or more domestic animals. A pet trust may only provide for the care of animals alive during the trust creator's ("settlor's") lifetime; it may not continue for the benefit of the progeny of the original pets or other animals born after the settlor's death. The settlor may designate a trustee to carry out the terms of the trust and specify a person who can enforce the trust on behalf of the animal in case the trustee is not acting faithfully. If no one is designated to enforce the trust, the probate court can, of its own accord or upon the petition of someone having an interest in the welfare of the animal, appoint a person to enforce the trust.

The property of the trust may be used only for the care of the animal. However, if the probate court finds that the amount in trust is more than necessary to care for the animal, it can reduce the trust. In making such a determination, a court would likely consider the expected life span of the animal and its needs--a pet horse may be reasonably expected to live longer and require more costly care than a pet canary. If the trust does not specify how excess funds should pass, they will pass to the settlor's heirs. The trust ends at the death of the last animal or after ninety years, whichever comes first. Any remaining property in the trust passes as specified by the trust or to the settlor's heirs.

new york

The New York pet trust statute is similar to the newly enacted Connecticut law. However, a New York pet trust may not last longer than 21 years. This has proved problematic in the case of long-lived pets such as horses and parrots. A proposed amendment to the pet trust statute would eliminate the 21-year limit, but it is unclear when or whether the amendment will be adopted.

new jersey

New Jersey's pet trust statute has provisions similar to New York's.

massachusetts

Massachusetts has not yet enacted a pet trust statute. This means that a pet trust established by a Massachusetts resident (or a cash bequest that is conditional on the recipient's caring for a pet) is generally not legally enforceable against a trustee or beneficiary who fails to meet the conditions of the trust or bequest. While a pet owner living in Massachusetts may still establish such a trust or make such a bequest (i.e., it is not void as against public policy), you should be aware that there may be no legal recourse against a dishonorable recipient who ignores your intent. This limitation does not need to prevent Massachusetts residents from establishing pet trusts, so long as they truly trust the recipient to carry out the stated wishes.

Massachusetts is one of only seven states without pet trust legislation. A proposed statute entitled "An Act Relative to Trusts for the Care of Animals" was filed with the state's House of Representatives in 2009, and this statute would include the same sort of ground rules for pet trusts that have been already been enacted in New York, New Jersey and Connecticut. However, it is not certain when or if this statute will be enacted.