When Congress passed the law known as “EGTRRA” in 2001, Congress made a promise no one expected it to keep: to repeal the federal estate tax for one year in 2010. Despite repeated attempts (and more promises) to prevent repeal from taking effect, the law remains unchanged. This article provides an overview of the estate tax repeal and the planning opportunities presented in 2010.
Current Law. As of January 1, 2010, there is no federal estate tax. In 2009, the estate tax rate was 45% and the exemption amount was $3.5 million. If left unchanged, the estate tax will return in 2011 with a marginal rate of 55% and an exemption of $1 million.
Repeal Not Tax Free. Repeal of the federal estate tax should not imply “tax free.” Oregon’s inheritance tax, which ranges from approximately 6%-15%, continues to apply to estates in excess of $1 million in 2010.
Moreover, beneficiaries may now have to pay capital gains taxes that were not payable in the past. Historically, beneficiaries took an unlimited “stepped-up basis” in inherited property equal to the market value of the property on the decedent’s date of death. Frequently, basis was easy to establish and any capital gains were minimal. In 2010, the “modified carryover basis” rule limits an estate to an overall basis increase of $1.3 million (or $3 million for a surviving spouse). This may result in a basis significantly less than the date-of-death value of the property, and thus, 2010 estates exceeding $1.3 million ($3 million for spouses) may pay more capital gains taxes whenever the property is sold. Also, the 2010 rule may impose additional tax filings on not-yet-developed IRS forms, as well as difficulties establishing basis.
Furthermore, federal law still imposes a gift tax of 35% for 2010 on gifts that are not exempted by the $1 million lifetime exemption or the $13,000 annual exclusion ($26,000 per couple). Finally, given the considerable uncertainty regarding the generation-skipping transfer (GST) tax, the 2010 rules could effectively impose a greater GST tax burden if 2010 GST allocations are not respected.
Promises Kept? The general consensus until now was that taxpayers would never see the 2010 estate tax repeal that was promised in 2001, yet Congress has been unable to agree on estate tax reform. Commentators still speculate, even at the time of this writing, that Congress will retroactively impose estate taxes for 2010, or that Congress will give estates a choice of paying estate or capital gains taxes for 2010.
Planning Opportunities. Despite the uncertainty, 2010 does present unique planning opportunities. The repeal of the estate and GST taxes for 2010 presents complicated and possibly risk-laden opportunities for wealthy taxpayers to make large gifts to grandchildren and ensuing generations tax-free. For estates of decedents dying in 2010, there will be no estate tax (if not changed retroactively). For those unwilling to gamble - or to die - to take advantage of such “opportunities,” 2010 is a great year to make lifetime taxable gifts that exceed or do not qualify for the $13,000/$26,000 annual exclusion or $1 million lifetime exemption, since the gift tax rate of 35% this year is historically low.
Review of Documents. In view of the special situation for 2010, you may wish for us to review your estate planning documents this year, particularly if a death in the family may be probable this year. Also, since this is a great year to consider gifts to your grandchildren, please let us know if you would like to consider making additional gifts this year.
When the exemption returns to $1 million on January 1, 2011 - that is, if Congress keeps its promise for 2011, we expect many of our clients will suddenly find themselves exposed to federal estate taxes and may want to add tax provisions to their estate planning documents. Regardless of what happens or when, we will be ready to serve you whenever your need arises.