By: David M. Lenz and J. Paul Fidler
Schneider, Smeltz, Ranney & LaFond P.L.L.
Cleveland, OH
The new calendar year brought with it dramatic changes in the federal transfer tax laws. These changes could significantly affect your clients planning strategies or even alter the way in which their property is distributed under their existing estate plan documents. Below is a brief summary of the current state of the law and some of the issues that may arise for your clients.
What is Happening?
The entire federal transfer tax system shifted dramatically as of January 1, 2010. Below is a summary of the major changes in the tax rates and exemptions for the federal estate tax, the federal generation-skipping transfer (GST) tax, and the federal gift tax:
|
2009 |
2010 |
2011 (and thereafter) |
|
| Federal Estate Tax Rate |
45% |
N/A |
55% |
| Federal Estate Tax Exemption |
$3,500,000 |
N/A |
$1,000,000 |
| GST Tax Rate |
45% |
N/A |
55% |
| GST Tax Exemption |
$3,500,000 |
N/A |
$1,000,000 |
| Gift Tax Rate |
45% |
35% |
55% |
| Gift Tax Exemption |
$1,000,000 |
$1,000,000 |
$1,000,000 |
Another change that is only in effect for 2010 involves income tax basis of inherited assets. Under prior law, the income tax basis of an inherited asset was generally stepped up to its value at the owners death. In 2010, however, the deceased owners income tax basis will generally carry over to the heirs. This means an heir would likely pay capital gains tax when he or she eventually sells the asset.
These changes in the law were created in 2001 by legislation that included a 10-year sunset provision but was intended to lead toward permanent estate tax repeal. Once the political and economic environment shifted away from permanent repeal we, like most estate planning advisors, expected that Congress would pass legislation to extend the 2009 law and avoid the temporary repeal of the estate tax. Unfortunately, Congress was unable to approve such legislation. This inaction by Congress has caused great anxiety among planners and clients. Congress may address transfer taxes this year with a law that applies for the rest of 2010, or even one that applies retroactively back to January 1, 2010. It is unclear whether Congress will be able to pass such a law and, if so, what the substance of the law would be.
It is important to note that notwithstanding these federal changes, your states estate tax system may continue to apply in 2010 as in previous years.
Why Does This Matter?
The current suspension of the federal estate and GST taxes may cause confusion in your clients estate plan documents. Key provisions in many estate plan documents refer to federal transfer tax concepts, such as the estate tax exemption amount, GST tax exemption, or marital deduction. Because those tax concepts are not in the law this year, there may be questions as to what the documents mean and how property is disposed of, particularly if the client were to die in 2010.
For example, consider a husbands Declaration of Trust that leaves an amount equal to the maximum amount that will be exempt from federal estate tax in trust for his children and leaves the balance of his estate to his wife. Under prior (and future) law, the childrens trust would preserve his full estate tax exemption, and the portion for his wife uses the marital deduction for the rest of his estate. As a result, no federal estate tax would be due at his death. This is a very traditional form of estate planning for married couples and continues to be generally appropriate. However, in 2010, when there is no federal estate tax, all of the husbands estate would be exempt from the federal estate tax. Therefore, all of his property may pass to his children, effectively disinheriting his wife!
Similar problems can arise pertaining to the marital deduction, GST tax exemption, or charitable deduction, depending on how a clients documents are worded. Formulas that were designed to produce an optimal transfer tax result could cause confusion or mis-allocation of assets if there is no federal estate or GST tax in effect at the clients death.
What Should You Do?
If your clients are concerned about these issues, you should encourage them to contact their attorney to review their estate plan. The kinds of issues described above are very case-specific and require consultation between the attorney and client concerning the clients current documents, goals, and wishes.
Further, the elimination of the GST tax, coupled with a reduced gift tax rate, may provide a unique opportunity for gifts in trust during 2010. Your clients may be interested in discussing these options. However, as was mentioned above, there is a possibility that Congress will reinstate the estate and GST taxes this year and make the law retroactive to January 1, 2010. These variables must be carefully considered before a client makes a substantial gift in 2010.
If you are interested in more detailed information concerning these changes in the law, please visit our website, www.ssrl.com, click on the Library, and click on the article entitled 2010 Estate Tax Repeal: How Did We Get Here and What Does It Mean?
IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that, unless expressly stated otherwise, any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter addressed herein.
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