Estate Tax Uncertainties
As you probably have heard, the federal estate tax rules changed radically in 2010 and will change radically again in 2011 unless Congress passes new legislation. This article will discuss what some of the changes can mean for you.
First, a little background:
The 2001 Tax Act. In 2001, Congress passed legislation which significantly increased the federal estate tax exemption and lowered tax rates. Among other things, the 2001 Act provided:
- In 2009, the estate tax exemption increased to $3.5 million per decedent, with a reduced 45% tax rate on any excess assets.
- In 2010, the estate tax is repealed for one year. In addition, the step-up in basis (which gave a “fresh-start” fair market basis for most assets of a decedent) is replaced with a more complex adjusted carry-over basis system.
- In 2011, the estate tax will be reinstated. However, the tax exemption will drop down to $1 million and the tax rate will jump up to 55%. In addition, carry-over basis will disappear and the step-up in basis will once again be the law of the land.
What Happened in 2009? Estate planners universally expected Congress to extend the favorable 2009 estate tax rules through 2010. However, unexpectedly in December, the House failed to enact a one-year extension and instead sent the Senate a bill to make the 2009 rules permanent. Because the Senate was focused on health care and there was broad disagreement in the Senate on what to do with estate taxes, it did nothing. Thus, effective January 1, 2010, there is no federal estate tax and the adjusted carry-over basis rules apply.
Estate Planning Is Now in Chaos. Congress’s failure to act in 2009 and the possibility that it will not act this year make for an unpredictable planning environment in which any number of radically different changes may occur.
Here are some of the possibilities:
Congress may do nothing this year. While you probably will not die in 2010, you still need to consider planning for that possibility because not doing so could be disastrous. For example:
- Trust language that allocates your estate tax exemption to a “family trust” could disinherit or place undesirable restrictions on a surviving spouse or other heirs.
- Conflicts could arise on asset basis issues.
- Passing assets directly to your spouse may result in higher estate taxes after 2010.
- Congress may retroactively adopt legislation to carry the 2009 rules over 2010. If a retroactive law is adopted, it will most likely be challenged as unconstitutional and it could take years for the Supreme Court to rule on the issue. Until such a ruling, uncertainty will prevail. In any event, your estate plan should contemplate your dying both before or after a potential retroactive enactment.
Congress may act to address the tax issues, in which case it may:
- Adopt a permanent estate tax exemption. If so, most commentators anticipate the tax exemption will fall between $2-5 million and tax rates will range from 35% to 45%.
- Adopt a temporary estate tax exemption.
What Should You Do? Uncertainty makes it difficult to plan, but waiting to see what happens next is not a good idea. The earlier you can implement flexible tax and estate planning to respond to these changes the better. Please call us to schedule a time to go over your current estate plan and determine what changes need to be made to minimize taxes and to reduce the possibility of future family conflicts in these chaotic times.
Lee Flaherty