“Estate Tax “Repeal” and Other Tax Law Changes." Trusts & Estates Newsletter. (May 2010)

The federal estate tax rules changed radically in 2010, and could change radically again in 2011 unless Congress passes new legislation. This Newsletter is intended to advise you of what has happened and encourage you to reevaluate your estate plan as soon as possible.
 
Estate Tax Repeal. In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) which provided for significant phased-in increases in the federal estate, gift and generation-skipping tax (GST) exemptions and lower tax rates. At the end of this Newsletter is a chart illustrating these tax exemptions and rates.
 
As you can see from the chart, in 2010 the federal estate and GST taxes are repealed for one year (technically the estate and GST taxes are not repealed but are “not applicable” in 2010). The gift tax $1.0 million exemption remains, with a lower tax rate of 35%. Thus, you have to die, pay gift tax, or make a GST transfer (a gift to a grandchild or more remote descendant) to possibly benefit from any of these changes.
 
Unless Congress acts sooner (which is becoming more unlikely as time passes), on January 1, 2011, EGTRRA will be automatically repealed, resulting in a $1.0 million estate tax exemption and a top estate tax rate of 55% (60% for the portion of estates over $10 million).
 
State Estate Tax Laws. It is also important to realize that there is currently no Missouri or Illinois state estate tax that is applicable to decedents dying in 2010. In 2011, both Missouri and Illinois will revert to estate taxes equal to the federal credit for state estate taxes paid (referred to as “pick-up taxes”) with exemptions again linked to the federal exemption of $1 million.
 
Carry-Over Basis. In 2010, the step-up in basis rules (which gave a fair market value basis to most assets of a decedent at death) are replaced with new carry-over basis rules. With carry-over basis, the beneficiaries of your estate receive a basis in your assets equal to the basis you had before death – in other words your basis “carries over” to the beneficiaries. However, the new basis rules permit a step-up in basis of up to $1.3 million in assets, plus an additional $3.0 million for transfers at death to your spouse outright or in a qualifying “QTIP” marital trust that pays all of the income to the surviving spouse.
 
Planning During Uncertainty. Congress’s failure to adopt estate tax legislation in 2009 and the possibility that changes will not be adopted during 2010, radically change the estate planning considerations of many clients. For example, Congress has indicated that in 2010 about 6,000 decedents will benefit from the elimination of estate taxes. However, over 70,000 heirs will pay higher income taxes because of the change in the income tax basis rules for assets received from decedents.
 
Any number of changes may occur in 2010. Congress may do nothing in 2010. If so, there is an adjusted carryover basis, and no federal estate or GST tax for people who die in 2010. While you probably will not die in 2010, you still need to consider planning for that possibility, because not planning for these changes can be disastrous if death occurs in 2010.
 
For example:
  • Formula clauses (provisions that allocate your estate tax exemption to a “credit shelter” or “family” trust) in your Wills or revocable trusts could inadvertently disinherit some beneficiaries, including your surviving spouse.
  • These formula clauses may also create conflicts among family members on how your Will or revocable trust should be interpreted.
  • Conflicts could also arise among your beneficiaries and fiduciaries on the allocation of basis among assets.
  • Inadvertent GST taxes could be incurred after 2010 due to incorrect assumptions on the amount of your remaining GST exemption or because you died during 2010 when there was no GST exemption available.
Congress may adopt legislation to carry the 2009 rules over to 2010, retroactive to January 1, 2010. Most commentators believe a retroactive tax bill would eventually be found constitutional, but it could take years for the Supreme Court to rule on the issue. Until such a ruling, the uncertainty in the law will continue to make planning difficult. Your estate plan should contemplate your dying both before or after a potential retroactive enactment, which may or may not be constitutional. The potential retroactive tax law change also makes taking advantage of the current 35% gift tax rate and repeal of the GST tax more complicated.
 
Income Taxes in 2011. Another change that is relevant to many estate planning transactions, is that in 2011 the reduced income tax rates also expire. The 10%, 15%, 25%, 28%, 33%, and 35% tax brackets will be replaced by 15%, 28%, 31%, 36%, and 39.6% brackets. In addition, the top rate for long-term capital gains will rise from 15% to 20% and the 0% rate for those in the lowest tax brackets will be replaced by a 10% long-term capital gains rate. Qualified dividends will also be taxed at ordinary income tax rates beginning in 2011.
 
Additional Taxes in 2013. Beginning in 2013, the new federal health care laws impose an additional 0.9% tax on earned income that exceeds $200,000 ($250,000 for married couples filing jointly). Beginning in 2013, the health care laws also impose a 3.8% “unearned income Medicare contributions” tax on certain investment income of higher-income taxpayers. The 3.8% tax is imposed on the lesser of: (i) net investment income, or (ii) the excess of modified adjusted gross income over a threshold amount ($250,000 for joint filers; $125,000 for married individuals filing separately; and $200,000 for all other individuals).
 
Please call a member of the Trusts & Estates Practice Group if you have any questions or would like to schedule a time to review your current estate plan. Or contact us if would like additional information on Roth IRA Conversions in 2010 and possible changes in the law to grantor retained annuity trusts (GRATs) and discount planning.

 

 Year

Estate Tax
Exempt
Amount1

GST
Exempt
Amount

Estate Tax
and GST
Tax Top
Bracket

Gift Tax
Exempt
Amount

Gift Tax
Top Bracket

Annual
Exclusion

 2001

 $675,00  

 $1,060,000

 55%

 $675,000  

 55%

 $10,000

 2002

 $1,000,000  

 $1,100,000

 50%

 $1,000,000

 50%

 $11,000

 2003

 $1,000,000  

 $1,120,000  

 49%

 $1,000,000

 49%

 $11,000

 2004

 $1,500,000

 $1,500,000  

 48%

 $1,000,000

 48%

 $11,000

 2005

 $1,500,000

 $1,500,000

 47%

 $1,000,000

 47%

 $11,000

 2006

 $2,000,000

 $2,000,000

 46%

 $1,000,000

 46%

 $12,000

 2007

 $2,000,000

 $2,000,000

 45%

 $1,000,000

 45%

 $12,000

 2008

 $2,000,000

 $2,000,000

 45%

 $1,000,000

 45%

 $12,000

 2009

 $3,500,000

 $3,500,000

 45%

 $1,000,000

 45%

 $13,000

 2010

 Repealed

 Repealed

 Repealed

 $1,000,000

 35%2

 $13,000

 2011 and
after

 $1,000,000

 $1,000,0003

 55%5

 $1,000,000

 55%

 $13,0004

____________________________
1The available estate tax exempt amount is reduced by any gift tax exempt amount used during the decedent’s lifetime. For example, if an individual made lifetime taxable gifts of $1 million between 2002 and 2009 and died in 2009, an additional $2.5 million would have been estate tax free ($1 million + $2.5 million = $3.5 million exempt amount).
2The gift tax rate in 2010 is linked to the top marginal income tax rate, which is 35% under EGTRRA.
3The GST tax exempt amount for the year 2011 will be increased based on a cost of living adjustment.
4The annual exclusion amount is subject to a cost of living adjustment.
5The tax rate is 60% for the portion of estates exceeding $10 million.
 

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