Client Alert
Changes in Estate Tax Law Result in Uncertain Planning
In December, 2009, the United States Congress adjourned without reaching a compromise agreement on the U.S. estate tax. As a result, on January 1, 2010, the U.S. estate tax and generation-skipping transfer (GST) tax were repealed for one year. The U.S. gift tax was not repealed. These important changes in the Federal transfer tax law raise many unanswered questions and could have significant consequences to your personal estate plans. This Client Alert will summarize the changes in the law, answer some of the questions that you might have, clarify some of the misconceptions that recent media reports might have created, and explain some of the possible ways that the current stalemate in Congress might be resolved.
- What are the major changes in the Federal transfer tax law that took effect on January 1, 2010?
For the estates of decedents dying and gifts made on or after January 1, 2010, the following major changes will apply in 2010:- The estate tax is repealed, and no estate tax will be due regardless of the size of the estate. In 2009, every decedent’s estate was eligible for up to a $3,500,000 estate tax exemption, and the estate tax rate was 45%.
- The GST tax is repealed, and transfers during lifetime by gift or upon death to grandchildren or more remote descendants and other “third generation beneficiaries” will not result in GST tax regardless of the size of the transfer. In 2009, the maximum GST tax exemption and rate were the same as the estate tax exemption ($3,500,000) and rate (45%).
- The gift tax is not repealed, however, the gift tax rate is reduced from 45% to 35%. The lifetime gift tax exemption of $1,000,000 remains the same.
- The basis of property acquired from a decedent will not be “stepped-up” to the value of the property at the time of the decedent’s death. Instead, the heirs’ basis in the property will be the lesser of the decedent’s basis in the property or the value of the property at the time of the decedent’s death. This change in the law is sometimes referred to as “carryover basis,” and it could potentially have significant income tax consequences to heirs who inherit low basis assets from an estate.
- The assets of every decedent’s estate will be eligible for up to a $1,300,000 increase in basis, and some assets passing to a surviving spouse will be eligible for an additional $3,000,000 increase in basis. Both the $1,300,000 increase in basis and the additional $3,000,000 increase in basis for assets passing to a surviving spouse require the executor of the estate to take affirmative action in order to be effective
- How did this happen?
In 2001, the United States Congress enacted a law (the “2001 Tax Act”) that phased out the estate and GST taxes and made many other important changes to the Federal transfer tax laws. The 2001 Tax Act provided that the estate and GST taxes would be repealed in 2010 unless Congress took action by December 31, 2009. In December, 2009, the United States House of Representatives passed a bill that would have permanently extended the estate, gift and GST tax law in effect in 2009. That bill would have made permanent a $3,500,000 estate tax and GST tax exemption, a $1,000,000 gift tax exemption, and a 45% rate. The United States Senate adjourned in December, 2009, without approving that bill or passing any other bill to extend the 2009 estate tax law.
- Will these changes in the Federal transfer tax law be permanent?
The 2001 Tax Act included a “Sunset Provision” that repeals all of the changes made by that Act as of December 31, 2010, unless future legislation extends those changes. Therefore, unless Congress takes action in 2010, on January 1, 2011, the estate and GST taxes will be reinstated as those tax laws were in effect prior to 2002. That means that the estate, gift and GST tax exemption will be $1,000,000, and the estate, gift and GST tax rate will be 55% (with a 5% “surtax” on some estates larger than $10,000,000). In addition, many other significant changes made to the Federal transfer tax laws by the 2001 Tax Act will be repealed.
- What is likely to happen in Congress in 2010?
We have stopped trying to guess what Congress will do about the estate tax, and we believe that any reports in the media predicting what Congress will do are mere speculation. However, we believe that there are generally four possible legislative outcomes in 2010.- Congress could either permanently or temporarily extend the estate, gift and GST tax law that was in effect in 2009.
- Congress could enact legislation that makes permanent, comprehensive changes to the estate, gift and GST tax law. At the end of 2009, there were numerous bills that had been proposed in both the House of Representatives and the Senate that would have made permanent changes in the Federal transfer tax laws, including the amount of the estate, gift and GST tax exemption (for example, from as little as $2,000,000 to as much as $5,000,000) and the maximum rate (for example, from as low as 15% to as high as 55%).
- Congress could do nothing, in which case the estate and GST taxes will be reinstated in 2011 as described above.
- Congress could permanently repeal the estate tax. Although this legislative outcome remains a possibility, given the current political alignment in Congress, we do not believe that this is likely to occur in this Session of Congress.
- Will any Federal transfer tax legislation enacted in 2010 be retroactive to January 1, 2010?
The Democratic leadership in Congress has stated that it plans to enact legislation early in 2010 to retroactively reinstate the estate and GST taxes as of January 1, 2010. The Republican leadership has stated that it will oppose any such retroactive legislation. Any such retroactive legislation would likely be challenged in Federal courts on constitutional grounds. However, the final resolution of such litigation could take many years.
- How will my personal estate plan be affected by the current repeal of the estate tax?
Many of you have wills and trust agreements that include “formulas” to determine what amounts of the estate will pass to different beneficiaries or to trusts for the benefit of different beneficiaries. Those kinds of “formula provisions” are based upon the estate and GST tax law in effect at the time of the client’s death. For example, a will or trust agreement could include a formula provision allocating the largest amount or percentage of the client’s estate that can pass free of estate tax to a “Family Trust” for the benefit of the client’s children and the remainder of the client’s estate to a “Marital Trust” for the benefit of the client’s surviving spouse. Depending upon the exact wording of the will or trust agreement, it is possible that this kind of provision would result in the entire estate passing to the Family Trust and nothing passing to the Marital Trust. Formula provisions allocating the “GST exempt” and “GST nonexempt” shares of the estate and formula provisions allocating charitable and noncharitable shares of the estate could present similar problems.
- What planning opportunities does the current change in the law present?
The combination of a lower gift tax rate (35%) and the repeal of the GST tax could create an opportunity for making substantial gifts directly or in trust for grandchildren and more remote descendants. However, by taking advantage of that opportunity now, you run the risk that the 45% gift tax rate and the application of the GST tax would be made retroactively effective to January 1, 2010.
- How will the change in the Federal estate tax law affect the State estate tax laws?
The answer to that question will depend upon the laws of the state of which you are a resident at the time of your death. For our clients who are North Carolina residents, as long as there is no Federal estate tax, under current North Carolina law, there will be no North Carolina estate tax. Of course, North Carolina could change its state estate tax law to make it apply to estates of North Carolina decedents independently of the Federal estate tax, or it could enact another kind of tax on property passing at death. For example, prior to 1999, North Carolina had a separate inheritance tax on the value of property inherited from a decedent. South Carolina currently has no state gift tax and no state estate or inheritance tax.
- What should I do now about my estate plan?
First, you should evaluate the importance of reviewing your personal estate plan with your attorney. Reports on the changes in the law that you read or hear in the public media can include incomplete or inaccurate information. There is no substitute for competent estate planning counsel.
Second, do not assume that the repeal of the estate and GST taxes will be permanent, or even that the repeal of the estate and GST taxes will last through 2010. For the time being, you should assume that the estate and GST taxes will be reinstated at some time in the future, possibly retroactively to January 1, 2010.
Third, on the other hand, do not assume that the estate and GST taxes will be reinstated at any time in 2010. In particular, if your estate planning documents contain the kind of “formula provision” described above, it is important that your attorney review those documents with you and advise you what, if any, changes should be made to your estate planning documents. There is no “quick fix amendment” that will work for every will and trust agreement. Every document should be reviewed by a competent estate planning attorney.
Fourth, in the event that “carryover basis” is the law for 2010, or for any part of 2010, you should consider what recordkeeping steps you should take to prepare your estate and your beneficiaries for “reconstructing” the basis in your assets after your death.
Finally, if a spouse, parent or another member of your family dies while the estate tax is repealed, contact your attorney as soon as possible. The many uncertainties in the estate tax law make it all the more important that you consult with your attorney and discuss what steps you should take to protect the assets of the estate for the heirs from unnecessary taxation.
We are prepared to answer these and any other questions that you may have. For a list of Womble Carlyle Trust and Estates attorneys please click here. We look forward to hearing from you.
Womble Carlyle client alerts are intended to provide general information about significant legal developments and should not be construed as legal advice on any specific facts and circumstances, nor should they be construed as advertisements for legal services.
IRS CIRCULAR 230 NOTICE: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. tax advice within this client alert 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 in a client alert.
