Surprisingly, Congress took no action in regard to the federal estate tax before the end of last year. As a result, current law provides for a temporary, one-year repeal of the tax, with a return in 2011 to the tax rules that prevailed in 2001, featuring a $1 million exemption amount and a top marginal rate of 55% for both the estate and gift taxes. Complicating the situation is congressional chatter suggesting that legislation will be passed sometime early this year, retroactive to the first of the year, reinstating some form of the estate tax for 2010.
If Congress does not act, here is a summary of the rules for 2010 only:
- There is no federal estate tax for people who die in 2010.
- There is no generation-skipping transfer (GST) tax for generation-skipping transfers that occur in 2010.
- The federal gift tax continues, with a $1 million exemption for lifetime gifts and a maximum rate of 35% (versus 45% in 2009).
- State estate taxes continue as they were. (As examples, Massachusetts and New York both have their own, independent estate taxes with exemptions of $1 million, while Florida has no estate tax.)
- New “carryover basis” rules apply for people who die in 2010, so assets passing from a decedent will no longer automatically receive a basis “step-up” for capital gains purposes. Instead, the new basis rules allow the executor of an estate to allocate up to $1.3 million of “increased basis” to any property passing from a decedent who dies in 2010, plus an additional $3 million of increased basis to property passing to a surviving spouse as “qualified spousal property.” Otherwise, assets will retain their pre-death basis.
If Congress does take action to “repeal the repeal,” it is impossible to predict with any certainty what rules will apply in 2010. Nevertheless, there are some signs the rules that prevailed in 2009 may be extended through 2010. (The House, but not the Senate, passed such legislation in mid-December and Senate Finance Committee Chair Max Baucus has stated that the Senate intends to extend the estate tax provisions without a gap in coverage.) By way of reminder, the 2009 rules provided for a $3.5 million exemption amount and a top marginal rate of 45% for both estate and generation-skipping taxes, a top gift tax rate of 45% , and a step-up in basis for any assets included in a decedent’s estate. After 2010, it remains unclear whether we will revert to the 2001 rules.
During this period of uncertainty, we are particularly concerned about existing estate planning documents that rely on formulas tied to the amounts of the federal estate tax exemption (such as commonly used “credit shelter formulas” or formulas for funding marital deduction gifts) or tied to the amount of the GST tax exemption. These formula gifts are dependent upon tax concepts that may not exist at the time of the person’s death, potentially causing intended gifts to fail or unnecessary taxes to be incurred. Another concern is whether our married clients have appropriately titled their assets, given the way increases in basis can be obtained (or not) under the new carryover basis rules.