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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• In 2010, the estate tax is repealed for one year.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

It has long been said that the only things certain in life are death and taxes. While most Americans pay any number of local, state and federal taxes while living, depending upon the extent of one’s property and the estate planning techniques used, additional taxes may be owed at death. According to the IRS website, “The Estate Tax is a tax on your right to transfer property at your death.” While the federal estate tax, therefore, has an impact on estate planning, the extent of that impact is currently in a state of flux. While death remains a certainty that all will face, the amount of federal estate tax is not.

In 2001, the Economic Growth and Tax Relief Act of 2001 (the “2001 Act”) was signed into law, significantly changing key provisions of the Internal Revenue Code dealing with the federal estate tax. Changes included an incremental increase in the estate tax unified credit exclusion from the pre-2001 amount of $650,000.00 per person, to $3.5 million per person in 2009, with no federal estate tax at all in 2010. In addition, the top estate tax rate declined from 55% to 45%. However, the 2001 Act contains a sunset provision and is set to expire on December 31, 2010. At that time the federal estate tax exclusion is scheduled to revert to $1 million per person and the maximum tax rate of 55% will be restored.

At 2009 rates, only inheritances above $3.5 million for an individual and $7 million per married couple were subject to the federal estate tax, at a tax rate of 45%. While it was estimated that only 1% of all inheritances would exceed those thresholds (encompassing an estimated 6,000 estates), Congress expected the federal estate tax to generate upwards of $25 billion in taxes in 2009.

Although there is no federal estate tax in 2010, the 2001 Act replaces the federal estate tax with a 15% capital gains tax on property inherited in 2010. Prior to 2010, beneficiaries of appreciated assets received those assets at their fair market value at the time of the decedent’s death (”stepped-up basis.”) Under stepped-up basis rules, the difference in the value of the asset from the time it was acquired by the decedent (the decedent’s “basis”) and the value of the asset at the time of the decedent’s death (the “gain” or “appreciation”) was not taxed as capital gains to the beneficiaries. This total exclusion no longer applies in 2010. While the capital gains scenario for 2010 is complicated and has its own system of exemptions, experts agree that many who thought that the elimination of the federal estate tax in 2010 would amount to a windfall may be in for a surprise.

The new capital gains treatment in 2010 notwithstanding, it is uniformly acknowledged that Republicans and Democrats alike are not going to accept the total elimination of the federal estate tax in 2010. In fact, on December 3, 2009, the House passed the Permanent Estate Tax Relief for Families, Farmers and Small Business Act of 2009, making permanent the $3.5 million per person exclusion, the 45% top tax rate, and stepped-up basis rules. However, the Senate, while focused on healthcare reform in the closing weeks of 2009, did not address the federal estate tax. As a result, the 2001 Act remains controlling — at least for now. Some Democratic Senators have vowed to reconvene early in January in order to pass an act that will be retroactive to January 1. As of this writing, the only thing that is certain is uncertainty.

We at Wright Penning & Beamer will continue to monitor this situation and the impact of future federal legislation on the estate planning needs of our clients. Stay tuned.

Duane L. Reynolds

On December 3, 2009, the House of Representatives passed a bill introduced by Rep. Earl Pomeroy (D-ND) that addresses the federal estate tax: H.R. 4154 - “A bill to amend the Internal Revenue Code of 1986 to repeal the new carryover basis rules in order to prevent tax increases and the imposition of compliance burdens on many more estates than would benefit from repeal, to retain the estate tax with a $3,500,000 exemption, and for other purposes.” This straightforward bill, which has no cosponsors, provides for the following:

- Repeal of the 2010 repeal of the federal estate tax as provided in the Economic Growth and Tax Relief Reconciliation Act (”EGTRRA”).

- Maintaining the $3,500,000 federal estate tax exemption in 2010 and beyond.

- Freezing the maximum gift tax rate and estate tax rate at 45%.

Legislation enacted in 2001 gradually phases out the estate tax and ultimately repeals the tax in 2010. However, without congressional action to make the repeal permanent, the tax will revert in 2011 to the pre-2001 rates.

There are currently 16 bills that address estate tax reform in various ways circulating in the House of Representatives and three circulating in the Senate.

Under current law, a $5 million estate in 2009 would pay $675,000 in federal estate taxes, according to an analysis by Deloitte Tax. In 2010, no estate tax would be due, but the estate would be subject to a 15 percent capital gains tax. In 2011, the $5 million estate would pay $2,045,000 in estate taxes, according to the analysis. Under this House bill, $675,000 in estate taxes would be due, regardless of which year the estate is inherited.

With the current estate tax law expiring after 2010, H.R. 4154 provides certainty to help business owners plan for the estate tax and it maintains stepped-up basis. However, a $3.5 million exemption per person and a 45 percent rate do not provide adequate protection for many small businesses and farmers. In addition, the $3.5 million exemption is not indexed for inflation; protection from the estate tax will erode each year.

Often, it is not a pile of liquid assets (cash) that is taxed, but the land of a family farm, personal effects, or the capital and assets of a family-owned small business. Without the cash on hand to pay these taxes, heirs are forced to sell off businesses and small farms that have been in the family sometimes for generations.

Estate taxes fall disproportionately on small business owners and farmers because many of the assets are illiquid. For example, approximately 80 percent of farm assets are land based. Surviving family members may be forced to sell land, buildings, equipment, livestock, etc., to keep their businesses operating. In many cases, however, the assets that must be sold to pay the estate tax are the most important inputs needed to maintain the business.

Employing the proper estate planning techniques can minimize and sometimes eliminate the federal estate tax burden on your estate. The attorneys at Wright, Penning & Beamer have assisted numerous families and businesses in regards to protecting the assets they have worked hard to earn during their life, minimizing the impact of adverse tax consequences. The result is maintaining the value of these assets that our clients work hard to acquire.

Heather Brenneman Miles

P.S. Check out the IRS’ 2010 Auto Mileage Deduction Rates Below:

The Internal Revenue Service has issued the 2010 optional standard mileage rates that are used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.
Beginning Jan. 1, 2010, the standard mileage rates are:

50 cents per mile for business purposes
16.5 cents per mile for medical or moving purposes
14 cents per mile in service of charitable organizations

The 2010 rates for business, medical and moving purposes are lower than last year’s, reflecting generally lower transportation costs compared to a year ago.

“…proper planning in most instances can navigate around any estate tax liability…”

There is a long history of debate regarding the federal estate tax. The implementation of the tax originally was to prevent the build-up of wealth that could lead to a creation of large estates and a permanent class of idle rich that would attempt to impose a monarchy.

While I am generally not in favor of raising taxes or the estate tax in general, there is a valid question as to whether the impact of the existence of the estate tax has any real negative impact on the majority of small business owners and family farms. Previously, President Bush tried to repeal the estate tax in his 2001 Tax Bill. President Bush succeeded to include provisions in the Bill that would phase the estate tax out of existence by the year 2010. The goal of the phase-out included in the Bill was to provide Congress with incentive to affirmatively decide the fate of the estate tax before its repeal in 2010. Now that President Obama has been elected, the fate of the estate tax has taken a different turn.

Under President Obama’s proposed new budget bill, there are provisions that freeze the estate tax at its 2009 level. The 2009 estate tax level provides for individuals with estates of up to $3.5 million to be exempt from estate tax which begins at a 45% tax rate, and married couples, with proper planning, can obtain an exemption of up to $7 million. In addition to using the aforementioned estate tax exemptions, there are additional estate planning tools which can, depending on the assets includable in an individual or married couple’s estate, provide for opportunities to possibly avoid estate tax on estates worth as much as $10 – 12 million or more.

The question then becomes is the estate tax a lion roaring down the path to chew up large pieces of individual’s estates, or is it a lamb in most instances avoidable and of no consequence?

According to a study by The Center on Budget Policy and Priorities, a Washington-based think tank, estate tax does not pose a significant problem to small business owners or individuals with family farms. That study claims that almost no small businesses or farm estates would owe any estate tax under the Obama budget bill. Based on the study’s analysis, fewer than .2% of all estates–2 of every 1000–will be subject to tax in 2009. Of the estates that are taxable, only about 1.3% are small business or farm estates. At the end of the day, the study purposes that only 3 out of every 100,000 people who die this year owning a small business or farm will be subject to any estate tax.

On the other side of the debate, the National Federation of Independent Business (NFIB) runs a separate organization, The Family Business Estate Tax Coalition, which primarily focuses its efforts to obtain a repeal of the estate tax. This organization argues that over the life of a business, the government collects income tax and other taxes. As a result, the group argues that the government has taken more than its fair share in taxes prior to an individual’s death. The organization further argues that the assets of a small business or family farm, including real estate, equipment, machinery and other business property can quickly add up to millions of dollars of value and yet only result in the production of a middle class income for the business or farm owner. While the individual, during their lifetime, may have paid for significant business assets, the group argues that the reality is that the individual only received a nominal return in income when compared to the overall value of the business assets.

The debate regarding estate tax will never cease as long as it is in effect. The lesson to be learned by an individual, small business owner or family farm owner is that proper planning in most instances can navigate around any estate tax liability.

Dan A. Penning
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Know Your Business, Grow Your Business, Protect Your Business