Estate Tax Repealed
A deadlocked Congress surprised tax and estate planners by not extending the federal estate and generation-skipping transfer (GST) taxes. The temporary repeal is effective January 1 and it’s for 2010 only.
Based on the tax-based formula often used in estate plans, this Congressional action can have unexpected results for heirs of persons who die in 2010, especially married couples. In some cases, if wills aren’t adjusted, a decedent’s assets could end up passing directly to the children or family trust, leaving the spouse out.
Estate tax repeal brings carryover basis rather than step-up in basis, which can have a significant impact on the income tax consequences for heirs.
Although some believe legislation will pass in early 2010 and the estate tax will be reinstated on a retroactive basis, nothing is certain at this point.
“These are roller coaster changes going on with estate tax legislation. If you have a wealthy family member nearing death, definitely review the basis and titling of assets to make sure estate documents will carry out your intended plans,” urges Sue Clark, tax principal with LarsonAllen.
Unless Congress acts otherwise, come January 1, 2011, both the estate and GST taxes will be reinstated at lower exemption levels and higher tax rates like they were prior to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA).
Why and how this repeal could affect wills and trusts
Most people anticipated Congress would extend the estate tax before the new year, yet, “We are unexpectedly dealing with legislation that did not pass,” sighs Clark.
Wills and revocable trust documents usually utilize a tax-based formula premised on the existence of federal estate tax. The “formula” provisions often defer the estate tax until the death of the second spouse, but make use of the first spouse’s estate tax exemption. The first spouse’s estate tax exemption is utilized by funding a family trust or bequest to the children in an amount that would result in the lowest or zero federal estate tax. Any amount that exceeded the federal estate tax exemption passed to the surviving spouse.
As an example in 2009, a person with $10 million in assets would leave the federal exemption of $3.5 million to the family trust, with the balance of $6.5 million passing to the spouse. In 2010, this would result in all of the decedent’s assets passing to the family trust, leaving nothing outright for the spouse. In addition, this situation can result in unexpected and significant estate tax in some states as well.
Review your will to address estate tax consequences
Many people made changes to estate plans when the 2001 tax act was passed; however, due to the complexity and potential length of will and trust provisions, a lot of documents did not address the estate tax consequences under all three of these scenarios:
- Increased exemptions and lower rates through 2009
- Repeal in 2010
- Return of lower exemptions and higher rates in 2011
“It is important that you have your estate planning documents reviewed to be sure they meet your goals and expectations,” explains Clark.
Future routes of action Congress may take
“With the polarization and partisanship that exists in Congress, it is almost impossible to predict when and if action will be taken to eliminate uncertainty and disparity in estate tax laws,” says Clark.
In the future, Congress could:
- Enact estate tax legislation, effective retroactive to January 1, 2010, and either extend the 2009 tax rates and exemptions or enact new rates and exemptions. Retroactive legislation would be subject to potential challenges regarding constitutionality.
- Enact estate tax legislation, effective on the date of enactment, and either extend the 2009 tax rates and exemptions or pass new rates and exemptions.
- Continue the deadlock and not enact legislation. This would leave repeal in effect for 2010, and the 2011 tax rates and exemptions outlined below would stay in place.
Changes with estate laws between 2009─2011 (and after)
The following tables summarize the up and down changes occurring to federal estate, gift, and GST tax laws.
2009
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- Estates of more than $3.5 million were subject to estate tax at a 45 percent rate.
- Gifts that exceeded the individual’s $1 million lifetime gift tax exemption were taxed at a 45 percent tax rate. To the extent the lifetime gift tax exemption was used, that person’s exemption from estate tax was reduced.
- When someone died, that person’s heirs inherited property with a step-up in basis—that means with an income tax basis equal to fair market value at the time of death. So the heirs could generally sell the inherited property without income tax consequences.
- During life, a person could gift up to $3.5 million to grandchildren without incurring GST tax. To the extent not used during life, the $3.5 million GST tax exemption was available for use at death. Generation-skipping transfers that exceeded the GST exemption were subject to tax at a 45 percent rate.
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2010
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- There is no federal estate tax.
- Some states will continue to have a state level estate tax, including Massachusetts, Minnesota, North Carolina, and Pennsylvania.
- The gift tax rate drops to 35 percent. The gift tax exemption remains unchanged at $1 million. Therefore, gifts that exceed the individual’s $1 million lifetime gift tax exemption will be taxed at 35 percent.
- When someone dies, the basis step-up at death is eliminated. Heirs will inherit assets with an income tax basis equal to the lower of the decedent’s basis or fair market value. There is a limited step-up available of $1.3 million and an additional $3 million of step-up available to a surviving spouse. The step-up can be increased by unused capital and net operating losses from the final individual income tax return.
- There is no GST tax.
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2011 (and After)
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- The estate tax exemption will be $1 million. Taxable estates in excess of $1 million will be subject to estate tax at rates ranging from 39 to 55 percent. The top rate of 55 percent will be imposed on taxable estates in excess of $3 million, with an additional surcharge of 5 percent for estates between $10 million and $17.2 million.
- The gift tax exemption is also set to be $1 million. Similar to taxable estates, taxable gifts in excess of $1 million will be subject to gift tax at rates ranging from 39 to 55 percent, with the top rate of 55 percent imposed on taxable gifts in excess of $1 million.
- Exemption from estate tax will be reduced to the extent a person’s gift tax exemption is used during his or her lifetime.
- When someone dies, that person’s heirs will inherit property with an income tax basis equal to fair market value at the time of death. Generally, this will result in the heirs being able to sell the inherited property without income tax consequences.
- The GST tax exemption is $1 million indexed for inflation since 1999. GSTs that exceed the GST exemption are subject to tax at a 55 percent rate.
- The state death tax credit will be reinstated. The credit will result in the return of an estate tax in many states, including California, Colorado, Florida, Illinois, Missouri, North Dakota, South Carolina, South Dakota, Texas, and Wisconsin.
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How we can help
For help reviewing your estate plan to make sure it fits with your intentions and the ever-changing estate tax system, contact a
LarsonAllen tax principal in your region. In addition, there may be a short window for tax advantageous opportunities when it comes to making gifts.