Client AlertsTemporary Federal Estate Tax Repeal Causes Uncertainty
The Federal Estate Tax has been repealed effective
January 1, 2010 -- at least for the time being.
It had widely been predicted that Congress would act before 2010 and would not allow the estate tax to be repealed. The House of Representatives did in fact pass a bill extending the tax, but the Senate failed to act. As a result, the provisions of a tax law that was adopted by Congress in 2001 have taken effect and the following has occurred:
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The Estate Tax has been repealed effective January 1, 2010, but only for one year. Unless Congress acts sometime in 2010, the Estate Tax will then be reinstated effective January 1, 2011.
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The Federal Gift Tax has not been repealed.
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Estates of individuals dying during 2010 are subject to a new, complicated "Carry Over" income tax basis regime.
It is possible (and maybe likely) that Congress will act to reinstate the estate tax during 2010. However, timing is very uncertain. Constitutional issues may prevent the tax from being reinstated retroactively to January 1, 2010.
It is now particulary important that you review your estate plan.
Until this year, the Federal estate tax has been imposed on transfers on death. The Federal gift tax continues to be imposed on lifetime transfers by gift.
A specified amount has been exempted from the estate tax. This “credit exemption” continually increased in recent years up to $3.5 million in 2009. The lifetime exemption for gift taxes remains fixed at $1,000,000. The estate tax rate in 2009 was 45%. The gift tax rate in 2010 is 35%.
Many wills and trusts use a “formula clause” which provides for the distribution of the assets of the estate in a manner designed to minimize or eliminate estate tax liability. Now that the estate tax has been repealed (at least for now), some formula clauses may produce unanticipated consequences which will not properly carry out the intention of decedent. If your estate plan contains a formula clause, we advise that you consult with us to determine how your estate will pass under 2010 law, and to examine whether or not that result accomplishes your goals.
Under the law in effect before 2010, the income tax basis of inherited property which appreciated in value during the decedent’s lifetime is generally “stepped-up” to equal the fair market value of the property as of the date of the decedent's death (or as of the date six months after the date of death, if an alternative valuation is elected on the estate tax return). This basis rule has been extremely beneficial to heirs because it allowed them to sell highly appreciated property at a new stepped-up basis, and thereby pay little or no capital gains tax. Capital gain is based on the difference between the sale price and the adjusted basis.
Under the new rule which is in effect for one year commencing January 1, 2010 (unless repealed by Congress during 2010), the basis of inherited assets will generally “carry-over” from the decedent, rather than being stepped-up to fair market value. When property which appreciated during the decedent's lifetime is then subsequently sold by the heirs, they may be subject to significant capital gain tax under the new rule. Unless detailed records are kept during the decedent’s lifetime, often for many decades, executors and trustees may have a difficult time establishing the carry-over basis of property. In order to determine carry-over basis, substantial information will often be needed, including the original purchase price of the property, the annual depreciation claimed on the decedent’s tax returns and the cost of all improvements made to the property.
There are two exceptions to the new carry-over basis rule. A step-up in basis will be allowed for certain assets up to a total of $1,300,000. Also, the basis of property inherited by a surviving spouse can also be increased by an additional $3,000,000. These exceptions do not apply to all property, and careful planning will often be required to take advantage of the exceptions. The executor of the estate will be responsible for determining which assets and to what extent each asset receives a basis increase under these exceptions. When allocating the limited stepped-up basis, executors may be put in difficult positions among competing heirs and may be subject to litigation. As noted above, subject to additional action by Congress, these new basis rules presently apply only to estate of individuals dying during 2010.
You should always periodically review your estate plan to make sure it is in line with your current objectives. The 2010 tax law developments now make it particularly important that you implement this review and consider any new planning opportunities that now exist.
If you have any questions about the 2010 tax law changes or if you would like to review your estate plan, please contact either Jon Samel, Diane Foxman or Andrew Grau at our firm, and they will be happy to assist you. 
