As has been discussed here on the Jeffrey Burr blog recently, the Estate Tax and Generation Skipping Transfer (GST) Tax have unprecedentedly been repealed. Currently, nothing indicates that the state of the Estate Tax will be changing any time soon. And while the constitutionality of a retroactive estate and GST tax is definitely fun to talk about, it seems as though such an act would pass constitutional muster. Our gut instinct is that Congress will take action sometime this year and implement a retroactive tax. That being the case, we echo the sentiment of many an estate planner in saying “the death of the death tax has been exaggerated.” Still, until pen is put to paper, a new Estate Tax regime has reared its head which requires our attention. As such, the following outlines some highlights and issues to consider given current law:
1. The absence of the estate and GST tax will only last during 2010. The gift tax is still in full effect for 2010; however, the rate at which it is now being assessed is 35% (as opposed to the 45% rate in place last year).
2. The welcoming cheers of a world with two less taxes should be somewhat dampened by the jeering heard over the loss of stepped-up basis. Prior to 2010, the cost bases of a decedent’s assets passing to beneficiaries were stepped up to their fair market value at death. This step-up in basis had the favorable effect of reducing built-in capital gains and the resulting capital gains taxes which were incurred upon the sale of any such assets. Under the new regime, cost basis on a decedent’s assets will carry over to the beneficiaries for the most part (see below), thus subjecting built-in gains to the full fury of income tax rates.
3. As a consolation prize for the loss of step-up in basis, the new tax regime is allowing a decedent’s personal representative to allocate $1.3 million of basis to built-in gains on property in a taxpayer’s estate. Furthermore, the personal representative may allocate an additional $3 million of basis to built-in gain on qualified spousal property. Qualified spousal property is property passing directly to a surviving spouse or property passing to a QTIP type trust.
4. As a reminder, even if the current tax regime remains in effect, these changes are to be short-lived (2010 only). Assuming no changes to the current or future Estate Tax laws are made, a previous tax regime, not seen since 2001, returns in full force in 2011 (i.e., $1 million of Estate Tax exemption, $1.3 million GST tax exemption, 55% max rate for estate, gift and GST tax, etc.).
5. Because most trusts were drafted with the expectation that hell would freeze over before the Estate Tax was repealed, many of these same trusts are now facing the serious potential of unintended disinheritances of spouses or children. This unintended consequence is the result of formulas within trust agreements that pide assets upon a spouse’s death based on the Estate Tax laws in place at the time of death. Where there is no Estate Tax, the formula referencing such is likely to be misapplied and achieve something entirely different than what the decedent intended. This issue becomes especially problematic when there are second marriages and step-children.
In closing, we would just like to say that all hope is not lost. As mentioned above, a retroactive tax seems sensible; however, the longer we go without a hint of congressional action, the more likely it is that 2010 will pass devoid of estate and GST tax. Either way, many will likely need to give some attention to the estate plan they currently have in place to determine what, if any, changes need to be made to address this unexpected occurrence. These changes could range from a complete overhaul of one's estate plan to simply putting a "band-aid" in place to get you through the year.
-Attorney Jeremy Cooper