Estate Tax Repeal: Unexpected But Not a Reason to Celebrate, or Panic
As was foreshadowed several weeks ago, Congress failed in its efforts to pass new estate tax legislation in 2009, and the federal estate tax was repealed as of January 1, 2010. It is likely, however, that Congress will act early in 2010 to restore the estate tax and do so retroactive to January 1, 2010. In commenting on the current situation, Representative Earl Pomeroy (D.N.D.) said "the prospects are 100% that Congress will come back next year and reinstate the tax, and make it retroactive to January 1, 2010." Of course we have learned that there is never 100% certainty about anything Congress intends to do.
The repeal of the estate tax as of January 1, 2010 was part of legislation enacted in 2001 which implemented a gradual increase in the estate tax exemption amount and reduction of estate tax rates. The legislation culminates with repeal of the estate tax in 2010, followed by reinstatement of the estate tax in 2011, with a reversion to the transfer tax rules in effect in 2001. That would mean a return to a $1 million estate tax exemption amount and a 55% top estate tax rate (with a 5% surtax applying to certain amounts in estates over $10 million).
The repeal of the estate tax in the 2001 legislation does not eliminate the tax consequences of death. In conjunction with repeal of the estate tax, the rules that step-up the tax basis of appreciated assets at death also are repealed, and replaced with a carry-over basis system, with certain exemptions. The exemptions allow an aggregate basis step-up for appreciated property capped at $1.3 million, plus an additional $3 million for property passing to or in a qualified trust for a surviving spouse.
Congress' inaction leaves taxpayers in a state of uncertainty as we enter 2010. There is no absolute guarantee that Congress will act in 2010, or whether they will make changes retroactive to January 1, 2010 if they do act. The lack of consensus in Congress creates doubt about what any new legislation will provide. Earlier in 2009, it appeared that a permanent extension of the $3,500,000 estate tax exemption and 45% top rate had broad support, but that no longer seems to be the case.
These developments are important, but are neither a cause for celebration or a reason to panic. No one should assume that the assets of a person who dies in 2010 will pass free of estate tax, even if the law says there is no estate tax on the date of the person's death. Congress has made retroactive tax law changes before and they generally are upheld. At the same time, the current state of uncertainty should not require any immediate wholesale changes to taxpayers' estate plans. Most well drafted plans will carry out the individual's fundamental dispositive goals unless and until Congress acts to create a new and different estate tax system.
This will not be the case for everyone, however. The plans of some individuals may be distorted if they die when no estate or generation-skipping tax is in effect. For example, some individuals have an estate plan that retains in long-term trusts for descendants the maximum amount of property that can be sheltered from generation-skipping tax, with any excess going outright to the children. In 2009, that plan for an unmarried individual would put $3.5 million into the trusts and give any remaining property to the children. If repeal actually stays in place in 2010 and the individual dies this year, all that individual’s property would pass to the long-term trusts. This may not be consistent with the individual's intention to leave some property directly to his or her children.
Some current estate plans also might not be ideally suited to take maximum advantage of the basis step-up rules that are now (at least temporarily) in place. The conundrum for taxpayers is whether to incur the cost of changes to their estate plans to address the impact of a one-year repeal – a repeal that could be eliminated retroactively and is only meaningful in any event if the person dies in 2010. While the analysis and possible changes to the estate plan in most cases will not be terribly complex, it is not a simple one hour diagnosis and cure either. Any individual concerned about the impact of repeal should contact their trusts and estates attorney about a review of the estate plan.
There is one additional important point. If Congress leaves repeal in place for 2010, there will be certain lifetime planning opportunities available, but that does not include an opportunity to transfer everything now and avoid all future transfer taxes. The gift tax has not been repealed. The lifetime gift tax exemption remains at $1 million. However, the gift tax rate does go down to 35% from 45%. The most significant lifetime planning opportunity will be with generation-skipping transfers. A married couple who is focused on maximizing the amount of property that can be held in long-term trusts may be able to transfer property (possibly unlimited amounts) to an irrevocable lifetime martial deduction trust in 2010. The transfer will not be currently taxable, but will be taxed at the death of the surviving spouse who is the trust beneficiary, assuming that death occurs when an estate tax is in effect. However, the trust property, and whatever it grows to in the future, may be permanently generation-skipping tax exempt. We do not know whether and to what extent this kind of planning will be available in 2010. Trusts and estates professionals are watching these developments closely and will jump on opportunities such as these if they materialize.