Estate Planning LegalALERT: Estate Tax Repeal – Or Not?

January 07, 2010

The estate tax laws have reached a new level of uncertainty this year! A number of changes are effective for just one year – maybe.

You may have heard that as of January 1, 2010, the federal estate tax has been repealed for one year. This means that under current law, no estate tax will be owed for an Alabama resident who dies in 2010, regardless of the size of his or her estate. (Some states, including Tennessee, have a separate state estate or inheritance tax that is not affected by the federal repeal.) The generation-skipping tax has also been repealed for one year. The federal gift tax remains in effect, however. The lifetime gift tax exemption stays at $1 million, but the gift tax rate has dropped from 45% to 35% for 2010. However, as described below, this legislation is scheduled to "sunset" on December 31, 2010, changing the estate tax rules yet again.

Although there may not be an estate tax in 2010, persons who inherit property in 2010 may owe a substantial amount of income tax on capital gains under the new "carryover basis" rules. Under pre-2010 law, inherited property received a new income tax basis equal to its value as of the decedent's date of death ("stepped-up basis"). Accordingly, an heir could sell inherited property and calculate the capital gains tax using the new, often much higher, basis rather than the decedent's original basis in the property. For property inherited from persons dying in 2010, however, the heirs generally must use the decedent's basis, with only a couple of exceptions: a basis increase is allowed for up to $1.3 million in appreciated assets, with an additional $3 million for assets passing to a surviving spouse. For many heirs, this will mean incurring income tax liability upon the sale of property that appreciated during the decedent's lifetime, assuming the decedent's basis can be determined.

If Congress does not take action this year, the rules will change again for anyone dying in 2011 and later years. Absent a change in the law, the estate tax and the generation-skipping tax will return in 2011, with only a $1 million exemption per person, and with tax rates as high as 60% for the largest estates. The carryover basis rules would be abolished, however, with a return to the traditional stepped-up basis rules for inherited assets.

It is possible that Congress will act sometime in 2010 to "repeal the repeal" of the estate tax and/or to change the carryover basis rules for 2010. The timing, terms and effective date of any such legislation are all unknown at this point. The federal estate tax could even be reinstated retroactive to January 1, 2010 (although it is likely that any such retroactive action will be challenged on constitutional grounds, adding to the uncertainty of the law in this year).

Most estate planning documents that were designed to minimize the estate tax have tax formulas designed to adjust for the changing estate tax exemption. In a year of full repeal, however, it is possible that the formula may not produce the result you intended. This would especially be true if your plan provides that the estate tax exempt amount is to pass to certain beneficiaries, with the rest of your estate passing to a different set of beneficiaries. For example, a Will that provides for the maximum estate tax exempt amount to pass to your children, with the remainder passing to your spouse, may, depending on the formula used and its interpretation under 2010 law, result in either the children or the spouse receiving the entire estate, which may not be your intent.

It is important for anyone whose estate plan includes the provisions described above, as well as anyone with estate planning documents that were prepared prior to December 31, 2001 (the effective date for this current law that was phased in over the past decade), to have their documents reviewed. Regardless of when you signed your estate planning documents, you may wish to discuss their interpretation under the potential one-year estate tax repeal to determine whether any changes to your estate plan need to be made to ensure that your intent is carried out. Changes could be as simple as a short Codicil or amendment if your documents were prepared fairly recently.

Please contact your Sirote attorney if you would like to have us review your estate planning documents and consult with you about whether any changes need to be made to react to this unprecedented estate tax situation.

Estate Planning LegalALERT: Estate Tax Repeal – Or Not?

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