News & Alerts
January 19, 2010
2010 Federal Estate Tax Repeal and Other Tax Law Changes
To the great surprise of nearly everyone, Congress was unable to accomplish expected revisions to the Federal Estate Tax in 2009. Consequently, the previously scheduled one-year repeal for 2010 that was not expected to survive did, in fact, occur as of January 1, 2010. While this repeal is, in many ways, welcome news, its unexpected arrival and uncertain future create an extremely difficult tax planning environment. The Wall Street Journal published an article on January 2, 2010, which summarizes how the repeal developed and discusses some of the implications of its ambiguous future. We have included a copy of that article with this correspondence.
Many in Congress have indicated an intent to promptly reverse this repeal and to apply such reversal retroactively. Therefore, although temporary repeal is the current law of the land, the true circumstance that will apply for 2010 remains very uncertain. Likewise, for the years beyond 2010, we have tremendous uncertainty as well. The laws in place currently call for the estate tax to return with a vengeance on January 1, 2011, back to an exemption level of only $1,000,000 (down from the 2009 level of $3,500,000). There is considerable hope and belief that Congress will act to increase those exemption levels considerably, but again, those details cannot be known and expectations vary substantially.
The generation-skipping tax laws and the generation-skipping tax exemption levels are also similarly affected by the current, temporary repeal and by the uncertain future of these laws, both within 2010 and beyond.
Another very significant change under the current 2010 law is the elimination of the basis "step-up" on inherited assets for capital gain and loss purposes. Under the law that applied up until January 1, 2010, the income tax basis of an asset was automatically changed to its current value as of its owner's death. This year, however, that automatic change would not occur, and the deceased owner's income tax basis in assets will "carry over" to the heirs who inherit those assets. However, under some fairly complicated new rules, the decedent's executor is given the ability to increase the basis of various assets, subject to certain total amount limitations.
These profound changes in the tax laws, and the tremendous uncertainty surrounding them for this year and beyond, create two very significant risks for existing estate plans. One is the risk
that language in existing documents tied to tax laws or exemption levels which have now changed may trigger unintended, adverse consequences as to the division and/or distribution of assets. The other is that existing documents could fail to take advantage of significant new tax planning opportunities created by these changes in the laws.
To help illustrate some of the impacts of these legislative changes, we have enclosed examples of a few common estate planning structures that may require significant revision. However, this is not a comprehensive summary and you should know that these tax law changes would have a significant impact on most estate plans. Please note, however, that we cannot assume responsibility for reviewing and updating your estate plan unless you instruct us to do so.
THE WALL STREET JOURNAL
Saturday, January 2, 2010
Estate-Tax Repeal Means Some Spouses Are Left Out
By MARTIN VAUGHAN
WASHINGTON-Spouses of those wealthy who die this year might find themselves with nothing if the family will isn't revised-a major wrinkle that could follow Friday's repeal of the federal estate tax.
As started on Jan. 1, estate taxes will be repealed for 2010 only. That means unless Congress acts otherwise, there is no limit to the wealth that can be passed on to heirs without incurring federal estate taxes through the end of the year.
But wills have often been written on the expectation that estate taxes were a fact of life for years to come, estate planners say. As a result, wills typically direct assets not subject to the tax be passed on to children-for 2009, up to $3.5 million-with the rest directed to the spouse.
"You could be in a situation now where everything would go into a trust downstream to the kids and nothing is left to the spouse," said Greg Rosica, a tax partner at Ernst & Young. "There is a need to revisit the basic estate-planning documents to make sure that what you intend to have happen really does happen."
Most states allow a surviving spouse to claim a portion of the estate, even if the spouse is disinherited under the will. But doing so can be time-consuming and expensive.
In 2011, the estate tax is scheduled to snap back to higher rates similar to those prior to President George W. Bush's tax cuts. The roundabout series of changes-the result of a compromise to pass the tax-cut legislation-has been on the books for years, but estate planners anticipated congressional Democrats would prevent the 2010 repeal from taking effect.
Instead, amid disagreement over the proper level for the tax and preoccupied with health-care legislation, lawmakers punted, and the tax disappeared.
"Ten years ago, there was a lot of gallows humor about repeal when everybody said it would never happen," said Rep. Richard Neal (D., Mass.), chairman of the House Select Revenue Subcommittee. "Now, one of those never-happen moments has happened, and nobody's laughing."
Mr. Neal said "there is no question" Congress will reinstate the tax, retroactively to Jan. 1, early next year. That is also the intention of Senate Finance Committee Chairman Max Baucus (D., Mont.). But others aren't so sure.
"There are plenty of instances where Congress has changed tax laws retroactively, but this one is particularly high-profile," said George K. Yin, a tax professor at the University of Virginia Law School and former head of the Congress's Joint Committee on Taxation. "Since Congress has had so much difficulty around a permanent estate-tax solution to begin with, there's no reason to think a retroactive solution would be less controversial."
The uncertainty has left those subject to the tax and their advisers with no end of planning conundrums, and a few opportunities.
In addition to the estate tax, the so-called generation-skipping transfer tax also disappears in 2010. That tax was imposed at 45% in 2009 on gifts to grandchildren.
There may be some hardy souls who bet Democrats in Congress won't succeed in passing a retroactive extension. These people may try to take advantage of the repeal of the generation-skipping tax by making large gifts to grandchildren. Those gifts would still be subject to the 35% gift tax in effect for 2010.
But there is substantial risk in making such a gift. If Congress passes a retroactive law, it could get hit with the 45% generation-skipping tax on top of the gift tax.
"I don't think many of my clients take that bet," said Justin Ransome, a partner in the national tax office of Grant Thornton. "If you're wrong, the toll charge becomes very significant."
As you can imagine, we expect to be extremely busy with these efforts on behalf of our clients. In an effort to respond to every client's request in a timely manner, we have structured a review process within our Estate Planning and Tax Group. Our Group has grown to six attorneys, five of whom have a Master of Laws in either Taxation or Estate Planning. When a client requests our review and assistance with these matters, our attorneys will work in a coordinated manner to first review the current plan structure and identify areas that likely need revision or alternative contingency drafting in light of the current and reasonably foreseeable legislative changes. After that internal review, we will meet with the client to discuss these details and recommendations, explore other issues and opportunities and confirm decisions so that all goals are addressed and brought current. In most cases, we will also ask the client to provide updated financial summary information to us in advance of the meeting, which may also include tax cost basis estimates for significant assets which have appreciated in value.
Your satisfaction and the optimization of your estate plan are both extremely important to us and it is our goal to ensure that we meet your needs appropriately at this important time. We will make every effort to respond to each client's request in a timely manner and hope you will have some patience with us, as may be necessary given the volume of effort that will be needed over a relatively short time period. Of course, we will try to accommodate, most quickly, those clients with serious health concerns or other emergencies.
If you would like us to begin the process of reviewing your current estate plan, please contact our offices at your earliest convenience. We will thereafter schedule a meeting with you to discuss the impacts on your current estate plan, as well as some of the new opportunities that may now present themselves. We are pleased to be of service to you and we appreciate your confidence in us.
EXAMPLE ONE
Scenario: My estate plan gives my tax exempt amount to my children or to a certain type of trust for the benefit of my spouse and/or descendants and distributes all of my remaining assets outright or in a different trust for my spouse.
Concern: These are very common estate plans which could now result in a distribution of assets that is dramatically different from the intended distribution. Under the new laws, this plan as drafted could completely disinherit my surviving spouse or significantly reduce the assets controlled by or held for my spouse's benefit.
EXAMPLE TWO
Scenario: My estate plan provides that if I die first, all assets are to be distributed directly to my spouse. Our combined net worth is under $3,000,000, so we expect no estate tax in either of our estates.
Concern: Although unlimited value can pass to a spouse with no estate tax at the first death, all combined net worth would become subject to estate tax when the second spouse dies, if it exceeds that second spouse's exemption. If the exemption level is then only $1,000,000, for example, all value above that would be taxed. I would have lost the opportunity to have sheltered all, or a large portion, of my own assets in a long-term estate tax-free trust for the benefit of my spouse and/or descendants. Further, many states now impose their own death tax, depending on the full net worth of the decedent and with relatively small exemptions, even against non-residents who merely own property there, depending upon the complete net worth of the owner.
EXAMPLE THREE
Scenario: I have high net worth and I will have made various dispositions of assets sufficient to capture and utilize any estate tax exemption level up to $5,000,000. My estate plan further provides that if I die first, all or a significant amount of assets are to be distributed directly to my spouse (such as by bequest in my will or living trust, or by beneficiary designation on my IRAs and life insurance or by joint ownership with rights of survivorship, for example).
Concern: If I were to die at a time when repeal of the estate tax was fully applicable or at a time when the exemption level was much higher than I had anticipated, the outright distribution of significant assets to my spouse will leave them potentially subject to estate taxes in my spouse's estate at his or her later death. If I instead directed those bequests into a marital trust for my spouse's exclusive lifetime benefit, I could potentially shelter all of that value from exposure to estate tax at my spouse's death and indeed, with generation-skipping trust planning, I could potentially shelter all of that wealth and its future appreciation from estate taxes in my descendants' estates for up to many generations.
EXAMPLE FOUR
Scenario: My estate plan distributes my tax exempt amount to my children and all other assets (or some percentage of them) are distributed to charity.
Concern: If I die while repeal of the estate tax is in place, my charitable bequest will be completely eliminated. Depending upon my goals and intentions, it may be necessary to amend or revise my plan documents.
On the other hand, even if repeal is not in place, the disposition of my estate is subject to very large swings depending on where the estate tax exemption level has landed for the year of my death. (Note $3,500,000 million in 2009 versus $1,000,000 in 2011, for example.) Drafting of other minimum "floors" or maximum "ceilings" on certain bequests may be needed.
EXAMPLE FIVE
Scenario: My estate plan distributes the Generation-Skipping Transfer (GST) tax exemption amount to a generation-skipping trust for my children and/or grandchildren and distributes all of my remaining assets outright or in a different trust for my spouse and/or children.
Concern: This is also a common estate plan structure for multi-generational planning which may now distribute assets in a way that differs from what was intended. The results of this structure are somewhat ambiguous where no GST tax regime exists at the time of death and will depend on the specific verbiage of your estate plan. If I die while GST tax is effectively repealed, this plan might completely disinherit my surviving spouse and/or my children or significantly reduce the assets subject to their control and benefit by distributing all of my assets to the first trust. The contrary interpretation of that ambiguity is that the share for my grandchildren cannot be funded at all, thereby defeating my intent and wasting the opportunity to structure a multi-generational, tax-free plan. Drafting of other minimum "floors" or maximum "ceilings" on such formula bequests may be needed.
EXAMPLE SIX
Scenario: My estate plan provides for the shares inherited by one or more of my children to remain in trust for them during their lifetimes (even those shares which might exceed my available GST exemption). Provisions governing such non-exempt children's trusts have often contained a trigger forcing trust assets to be included in the child's taxable estate upon death as a tradeoff to avoid a more expensive generation-skipping tax event.
Concern: If my death occurs when repeal of the GST tax is in place, that may be the functional equivalent my holding an unlimited GST exemption which may warrant adjustments to some of the tax trigger provisions I have drafted into the exempt and non-exempt trusts my plan establishes for my children.
EXAMPLE SEVEN
Scenario: My estate plan provides specific assets to certain individuals and all other remaining assets are split among my spouse and children.
Concern: The 2010 law repeals the estate tax, but also provides very special rules regarding allocation of income tax basis. It may be important to discuss who is to receive a "stepped up" basis in assets in order to avoid future income tax. This is particularly true if I have assets that have appreciated in value during my lifetime that would incur capital gains tax if and when such assets are sold.
These examples are not intended to cover all scenarios that are impacted and give rise to new issues under the new (and forthcoming) estate tax legislation. Every situation is unique and may require changes to take account of tax legislation and the client's specific intentions. It will often be necessary to develop alternative distribution provisions within the estate plan to appropriately cover two or more different scenarios that these wildly evolving laws are presenting to us.