In spite of what you may have heard about taxes in 2010, we believe Ben Franklin’s sardonic proverb, with Will Rogers’ prescient addition, still holds true – this year more than ever.
Nothing is certain but death and taxes – the only difference between the two is that death doesn’t get worse every time Congress meets.
For better and perhaps worse, this year is when the repeal of the federal estate tax took effect – but hold your applause. Congress merely substituted the estate tax with another method of taxation that will collect more taxes from many taxpayers than the estate tax! To make matters worse, the changes wrought by repeal of the estate tax for 2010 could cause disastrous financial consequences in some cases and greatly change the manner in which planned distributions of your estate are made upon death.
To compound and confuse matters even more, unless Congress passes new laws before the end of this year, in 2011 the federal estate tax and the little known generation-skipping transfer tax return again – with a vengeance!
We want to make you aware of these important developments and encourage you to reevaluate your estate plan as soon as possible. With proper planning, you can take steps to address the current laws so you, your loved ones and your estate don’t fall victim to the whims of Congress.
How Did We Get Where We Are?
A brief review of the law will help explain why this is so significant. The 2001 tax act gradually reduced the maximum rate of the federal estate tax (and the equally onerous generation-skipping transfer tax on transfers to grandchildren) from 55 percent to 45 percent. It also gradually increased the amount of property that you could pass free of federal estate tax from $675,000 per person in 2001 to $3.5 million per person in 2009. That means that with basic estate planning, a married couple could pass up to $7 million free of federal estate tax, if they both died in 2009.
Then, in the year 2010 only, the 2001 tax act repeals the estate tax. But like a horror film character who just won’t die, under the existing law the estate tax returns again on January 1, 2011, only at a much lower $1 million exemption and a higher maximum 55 percent tax rate. This strange “now it’s gone, no it isn’t” effect is the result of a rule in Congress that attempts to limit budget deficits.
Paying for Estate Tax Repeal
To pay for this one-year vacation from the estate tax, Congress replaced the estate tax with an increased income tax. Before 2010, any assets that passed to someone when you die would be valued at fair market value at the date of death. Thus after death, when a surviving spouse or heirs sold any inherited assets (like securities or a home) that had increased in value, they would not have to pay income tax on any of that growth that occurred during your life. (This is referred to as a “step-up in basis.”) For many heirs, this means huge income tax savings, oftentimes tens of thousands of dollars or more.
But in 2010, property that passes at death does not automatically receive this step-up in basis. Instead, each individual has only a limited amount of property that can be “stepped-up” in value at the time of death. Property that does not receive this step-up in value will be subject to tax on the entire increase in value from the date the decedent first acquired the property. This means that the property could expose your heirs to tens of thousands of dollars of income tax liability.
Not surprisingly, these rules are convoluted and in many cases very different from the old law. In fact, Congress attempted to institute a similar tax structure in the 1980s and it was repealed, retroactively, because it was too hard to administer. Because of past experience, as well as the anticipated difficulties in calculating such a tax, the common belief was that Congress would change the law before January 1, 2010. But it didn’t.
How Are You Affected?
This law can affect you in several ways. Even if it is unlikely that you will die in 2010, you still need to consider planning for that possibility. Not planning for these changes, if death does occur, could be disastrous for your survivors.
- Typical formulas used in estate planning documents for over 50 years could now inadvertently disinherit your surviving spouse or heirs and create conflicts among family members on how to interpret your documents.
- Conflicts could arise among heirs and also fiduciaries on asset basis issues.
- Passing assets to your surviving spouse may result in higher estate taxes after 2010.
- Inadvertent generation skipping taxes could be incurred after 2010.
- Inadvertent state taxes could be incurred because of the terms in your documents.
What Should You Do?
Have your estate planning documents professionally reviewed and brought up to date with current law as soon as possible. The earlier you implement flexible estate and tax planning to address the status wrought by Congressional (in)action, the better. This is a time that demands a new approach to your estate planning, with new thinking to see that your wishes are fulfilled no matter what Congress decides to do this year or next.