As you may know, as of January 1, 2010, the federal estate tax and the federal generation-skipping transfer tax (“GST tax”) were effectively repealed and replaced by an extremely complex “carryover basis” scheme which will last exactly one year. On January 1, 2011, the carryover basis regime will disappear and the federal estate tax and GST tax will reappear with a vengeance. Most estate planning professionals expected Congress to pass legislation last year which would have preserved the estate tax and GST tax as they existed in 2009, but the Senate ultimately failed to act. Many practitioners now believe that Congress will act in the next few months to retroactively restore these taxes. However, we would like to give you a general summary of the current law and notify you that it may change your estate plan in ways you do not intend.
Unless Congress restores these taxes for 2010, the estate tax will not apply to estates of persons who die in calendar year 2010, and the GST tax will not apply to generation-skipping transfers which are made in calendar year 2010. The assets of a decedent who dies in 2010 will not receive a “stepped-up” basis to their fair market value as of the decedent’s date of death, but instead will retain the decedent’s original “carryover basis” for income tax purposes. As a result, an individual who inherits an appreciated asset from a decedent who dies in 2010 could incur significant capital gain tax on a subsequent sale of that asset. However, the personal representative of a decedent who dies in 2010 will have up to $1,300,000 in additional basis to allocate to the decedent’s assets, as well as up to $3,000,000 in additional basis to allocate to assets passing to a surviving spouse. These new basis rules are complicated in their application to individual situations.
The federal gift tax still applies to gifts made in 2010, but with a maximum tax rate of 35% (down from 45% in 2009) and a $1,000,000 lifetime exemption amount. The annual exclusion from gift tax, the amount which an individual may gift to another individual in a calendar year without utilizing his or her $1,000,000 lifetime exemption or incurring gift tax, remains at $13,000 for 2010.
In 2011, the estate tax and GST tax will return with a maximum tax rate of 55% (up from 45% in 2009), a $1,000,000 estate tax exempt amount (down from $3,500,000 in 2009) and a $1,000,000 GST exemption indexed for inflation since 1999 (down from $3,500,000 in 2009). In addition, the “carryover basis” rules will be repealed and the “stepped-up” basis regime reinstated.
While the repeal of the estate tax and GST tax and the application of the new “carryover basis” rules will last only one year, it creates the potential for unintended results. In particular, some estate plans which contain formula gifts to spouses, other family members or charity which are specifically tied to estate and GST exemption amounts could be especially problematic.
For some clients, the current law may present planning opportunities. For example, if you are considering making taxable gifts to children or grandchildren in the next few years, you may want to make these gifts as soon as possible this year, before Congress acts and while the federal gift tax rate is 35% and there is no GST tax. Of course, you will need to keep in mind that Congress could reinstate the prior law retroactively to January 1, 2010. In that case, there almost certainly will be litigation over the constitutionality of that retroactivity which would take years to sort out. Any actions taken during this period of uncertainty will have to be carefully considered, with due regard being given to possible outcomes under various scenarios.
We believe that all estate plans, especially those which contain planning for estate and GST taxes, should be reviewed to make sure that the distribution of assets to beneficiaries will take place as intended under these new 2010 tax rules. In addition, you should contact us if you wish to make gifts of any size to a trust, make gifts which exceed your gift tax exempt amount or have not reviewed or updated your estate plan in the last five years. You should also contact us if you or an immediate family member is facing a serious illness.
We are pleased to review your estate plan and, when necessary, recommend changes. However, to avoid incurring legal fees without your approval, we will only review your estate plan upon your request.
In the meantime, we are keeping a close eye on the situation in Washington, D.C., and will inform you of any major developments as soon as possible.
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To ensure compliance with certain requirements imposed by the IRS, we must inform you that any U.S. federal tax advice contained in this letter is not intended or written to be used, and can not be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
Dudnick Detwiler Rivin & Stikker LLP
Thomas J. Stikker
Jeffrey T. Antonchuk
Francisco D. Silva