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 To the great surprise of the entire estate planning community nationwide, Congress failed to amend the complicated one-year repeal of the Federal estate tax for decedents dying in 2010.  Depending on whether you believe that this tax will be retroactively reinstated by Congress later in 2010, and whether you believe that any retroactive enactment would be constitutional, you may want to take action now to change your estate plan.

The original 2001 tax legislation enacted a gradual decline of the Federal estate and generation-skipping tax over a period from 2001 through 2010.  During those years, the exemption increased and the top marginal estate tax rate decreased.  In 2010, there will be no Federal estate or generation-skipping tax at all, but assets will generally receive a carryover basis.

Generally speaking, the new basis regime is to carry over the decedent’s basis in each asset as of the moment of death, or change to the fair market value only if lower.  Thus, if the decedent has accumulated his or her estate over a period of 50 years, buying securities, realty and other assets, it could be necessary to go back over 50 years of records in order to determine the cost basis of each asset. 

The law creates two important exceptions to this carryover basis rule, however.  First, each estate gets a $1.3 million increase in basis (plus unused losses and loss carryovers), assuming the assets in the estate have appreciated at least that much and are of a kind that are eligible for a basis step-up at death (e.g., excluding IRAs).  For those estates which have more than $1.3 million in appreciation as of death in such assets, then it is possible to obtain up to another $3 million in basis increase for qualifying assets which pass to the spouse outright or in a marital trust.  To maximize the basis increase, the estate plan must be written to take advantage of both of these exceptions.  In some cases, gift transfers to a dying spouse by the other spouse can help utilize this basis adjustment.

Because the one-year repeal of the Federal estate tax was combined with a reduction in the basis step-up at death, and because the latter rules were added at the last minute in a slap-dash fashion, all estate planning pundits predicted, at the very least, technical corrections to the basis adjustment rules, if not a total change in the law.  However, as we have all read, and despite legislative initiatives almost every year since 2001, no change to the law was made.  In late 2009, the Senate failed to pass a one-year extension of the Federal estate tax.  Some predict that it will be difficult for the Senate to pass retroactive legislation in 2010 reinstating the Federal estate tax, given the 60 vote requirement in the Senate, the solid Republican voting bloc and the defection of several Democrats to the Republican view on this subject in late 2009.  Health care legislation in early 2010 and election year politics thereafter complicate the picture further.

What, then, does this mean to you?  It affects you most if you are either a married couple with over $2.5 million of appreciation in your estate, or are in a second or subsequent marriage or if you have left your estate tax exemption amount in a formula bequest to one or more designated beneficiaries.  In each of these cases, this repeal of the estate tax could distort your estate plan should you die in 2010 and should the Federal estate tax not be retroactively (and constitutionally) reinstated.  While we at Greenebaum Doll & McDonald PLLC cannot foresee the political future of the estate tax issue, we did feel it necessary to make you aware that the Federal estate tax had been repealed for one year and could affect your estate plan should you die during an effective period of repeal.  If you wish to address this issue in your own plan, including a specific set of provisions covering the scenario of no estate tax, please contact your estate planner at our firm.

There are some opportunities in the new law too.  The gift tax survives, with a $1 million lifetime exemption and a reduced 35% rate.  Further, the generation-skipping tax has been repealed both for gifts and estates in 2010.  Generation-skipping gifts, as well as distributions from existing non-exempt generation-skipping trusts, would be favored by the new law.  The risk is that Congress might revoke these tax benefits by passing retroactive changes later this year.

We at Greenebaum Doll & McDonald PLLC have watched these issues closely over the years, but like most estate planners felt that it was not in our clients’ best interests to plan for a tax law situation that was widely predicted to be changed legislatively before it took effect.  At this point, since Congress has defied all of the predictions, we feel compelled to bring this issue to you for your own consideration and decision as to whether or not action should be taken.

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