year where there is no federal estate tax – but hold the cheers. Congress has substituted another method of
taxation that will collect more taxes from many of our clients and families
than the estate tax. Additionally, as
has been reported in the local and national press,[1]
these changes will, for some, greatly alter the planned for and anticipated
distributions among family members and heirs.
of the law will help explain why this is so significant. The 2001 tax act, signed into law by
President George W. Bush, gradually reduced the maximum rate of the federal
estate tax (and the equally onerous generation-skipping transfer tax on
transfers to grandchildren) from 55% to 45%.
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 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% tax rate! This
strange “now it’s gone, no it isn’t” effect is the result of a Congressional rule that attempts to limit budget deficits–and we all know how good Congress is at avoiding budget deficits.
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 pass 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 assets (like securities or a home)
that had increased in value, they would not have to pay capital gain tax on any
of the growth that occurred during your life.
(This is referred to as a “step-up in basis.”) For many heirs, this means huge 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 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 value will be subject to tax on all increase in value from the date you first acquired the
property. This means that the
property could be exposed to tens of thousands of dollars of income tax
liability for your heirs!
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 difficult 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.
affect you in several ways. For married
couples as well as single clients, we need to first make sure that your property
will be divided according to your
desires, and not by the dictates of Congress. For more than 50 years, it has been common to
use a written mathematical formula to divide the assets of a married couple
when the first spouse dies to maximize estate tax savings. Likewise, formulas have been used to provide
funds for charitable causes and to benefit family and friends. Now, in 2010, when there is no estate tax,
these formulas will not work. If a
spouse is not your sole beneficiary (for example, if you have children from a
prior marriage), the existing formula could result in the disinheritance or
substantial reduction of resources provided for the surviving spouse.
What Should You Do?
We encourage you
to meet with your trusted advisors as soon as possible to review your estate plan and make any
changes that are necessary. It is critical
to ensure that your property is positioned to receive the maximum step-up in
basis increase available under current law. This is a time that demands a new approach to
your planning with new thinking and building in flexibility to assure that your
wishes are fulfilled no matter what Congress throws at us this year or next. We can offer solutions that will meet your
planning objectives with the least amount of tax impact.
[1]
See Estate-Tax Repeal Means Some Spouses Are
Left Out, January 2, 2010 Wall Street Journal and A Bizarre Year for the Estate Tax Will Require Extra Planning,
January 8, 2010 New York Times.