Can We Only Expect the Unexpected from Congress?

Your estate plan may need a tax checkup!

Sign after sign from Washington in 2009 suggested that Congress would repeal the estate tax repeal, or at least extend 2009's $3.5 million applicable exclusion from estate tax into 2010. It never happened. As a result, for individuals dying in 2010, the estate tax has now actually been repealed, as legislated all those many years ago, in the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA").

While the repeal of the estate tax might sound like something to celebrate, the party will be short-lived, and seemingly restricted to those who plan to die in 2010 (or, ironically, to their loved ones?) - as Congressional action in 2001 also provided for the rebirth of the estate tax in 2011, for all estates in excess of $1 million.

Meanwhile, the temporary repeal of 2010 also brings a new set of potential problems for the unwary – among them the end of an unlimited “step-up” in basis for assets owned at death - thus sticking the heirs with "carryover" basis, and potential capital gains tax to be paid on the sale of inherited assets. (The new "carryover" basis rules create a potential administration nightmare, as executors and trustees (or the heirs themselves) scramble for documentation to establish the basis of assets acquired by a decedent decades ago.)

All these changes translate pretty directly into reasons to have your estate plans reviewed – soon - even if you have had a review in the last few years – and most particularly if your “gross estate” (add your life insurance death benefits to the value of the property you own) exceeds $1,000,000.

Among those who may be most likely to want to make adjustments in their estate plan are those with tax motivated trust designs, and particularly those with “formula clauses.” Many of our clients have made wise use of formula clauses in the past; and while some of these have been converted to disclaimer funding schemes since the 2001 legislation made the estate tax threshold a rapidly moving target, many will persist. Those who have children from a prior marriage should be particularly wary, as should anyone with extensive holdings of appreciated assets, and as should those whose planning includes deliberate generation-skipping gifts (the separate generation skipping tax comes and goes with the estate tax).

The repeal of the estate tax will cause many estate plans with formula clauses to either: (1) leave everything to the "Credit Shelter Trust," or "Bypass Trust," (2) leave everything to the surviving spouse, (3) leave everything to the children of the deceased spouse, to the exclusion of the surviving spouse, or (4) potentially require court interpretation as to what was intended by the decedent. Where the plan includes generation-skipping formulas, the plan may disinherit children (in favor of grandchildren), or (perhaps a lesser problem) subject a child’s entire inheritance to being tied up in trust, when it was desired to allow them a greater measure of freedom.

Beyond this, the “carryover” basis rules come with some limited opportunity for step-ups in basis, up to $1.3 million of additional basis to assets going to anyone, and up to $3 million in additional basis to certain assets passing to a surviving spouse, but your current plan may not allow you to take maximum advantage of these rules, and thus leave significant tax savings (for your beneficiaries) on the table.

Bottom line - your estate plan may not yield the desired result if you die in 2010.

At the same time, given the elimination of the generation skipping transfer tax and lowering of the gift tax rate to 35 percent (for transfers in excess of the $1 million lifetime exclusion), now may be the time to act for clients with large estates and a desire to leave significant assets to grandchildren (or great-grandchildren). However, the window of opportunity will be short, no matter what course of action Congress takes.

Commentators have all kinds of ideas about what Congress might or might not do in 2010, including a retroactive reinstatement of the estate tax (and of the generation skipping tax). No one can know what Congress will do but, whatever Congress ends up doing, you will want to review your existing estate plans as soon as possible to avoid unwanted consequences in the event of death this year.