Estate Tax Repeal and Other Tax Changes

The year 2010 may provide significant planning opportunities for some and potential pitfalls for others due to Congress’s unexpected failure to agree on estate tax legislation prior to the end of 2009.  The purpose of this letter is to provide you with background on the current situation and how it may affect you.

BACKGROUND
Federal.  In 2001, significant changes to federal estate, gift and generation-skipping tax (GST) laws were enacted, including repeal of the federal estate tax and GST in 2010.  To meet Congressional budgetary requirements, the 2001 law had a “sunset provision” under which the rules in place prior to 2002 would return in 2011 unless Congress took further action.  All of the “experts” expected the situation to be resolved prior to repeal in 2010.  A resolution did not happen.  As things now stand, the applicable tax exemption amounts and rates for 2009-2011 are as shown below.

Together with the repeal of the estate tax, we have a repeal of the “step-up” in basis and now have “carryover” income tax basis.  At least for 2010.

In general, step-up means that the basis in assets owned by a decedent is adjusted to the fair market value as of the date of the transferors death. 

Carryover basis, on the other hand, means that property which passes from a decedent will have a basis equal to the lesser of its value at the transferor’s death or of the transferor’s basis.  This means potentially more income taxes will be due when the property is later sold.  The new carryover basis rules do provide for $1,300,000 of appreciation basis that may be stepped-up for assets generally plus an additional $3,000,000 of appreciation basis that may be stepped-up for property passing in certain ways to the surviving spouse.  Unless reinstated during the 2010 calendar year, in 2011 the income tax basis rule of fair market value at death will again apply as it did for deaths before 2010.

Minnesota.  Prior to 2002, Minnesota, like most other states, imposed an estate tax equal to the federal death tax credit.  In general, this meant no more in overall estate tax was paid, just that some estate tax was paid to Minnesota and the balance was paid to the federal government. 
Due to the federal estate tax changes passed in 2001 and state budgetary restraints, Minnesota “decoupled” from the federal estate tax in 2002.  The current Minnesota estate tax (Minnesota does not have a gift tax or a GST tax) exemption is $1,000,000, and no increases in it are scheduled.  The Minnesota nominal estate tax rates above the $1,000,000 exemption vary from 5.6% to 16%.  It is possible to owe Minnesota estate tax even if no federal estate tax is due.  Moreover, the Minnesota Department of Revenue has taken the position that certain elections, such as the election to treat a qualifying trust as eligible for the marital deduction, can be made for state purposes only if made on a federal estate tax return.  A federal estate tax return often is not filed (and at this time none are due for deaths during 2010) even when a Minnesota estate tax return is required.

THE FUTURE OF THE ESTATE TAX, GST AND GIFT TAX
Federal.  The estate tax exemptions in effect at year-end 2009 may be retroactively extended through 2010 effective on January 1, 2010.  It is possible that such a change would be challenged as unconstitutional.  However it is also possible that no bill will be passed this year and we will reset back to 2001 exemption levels in 2011.  Or it is possible that a bill would pass in 2010, without being retroactive, in whole or part, back to January 1, 2010, either by choice or due to a successful constitutional challenge.  Another possibility is that a more permanent fix is made in 2010 and, as before, the estate, GST and gift taxes would have the same exemption amounts and the nominal estate and gift tax rates are lower than in 2009.  No one knows for sure what will happen and it is possible that whatever Congress does or does not do may look completely different than what we are thinking at this time.

Minnesota.  Given budgetary constraints, we believe that pro-taxpayer changes in Minnesota estate taxes are not likely in the near term. 

ADVISABLE ACTION
We suggest that you review your estate planning documents every couple of years to ensure they still accurately reflect your intent and circumstances.  Now is a good time to do that.

The estate tax repeal may change the intended distribution of your estate plan depending on the language in your Will or Trust.  For example, a bequest to a spouse may not be funded because the amount may depend on federal estate tax concepts that presently do not exist.

Another example is that a direct or indirect bequest to a charity may be described in terms of a percentage of “federal taxable estate,” a term that technically no longer exists. 

PLANNING OPPORTUNITIES
As mentioned above, the gift tax rate for 2010 is now 35%.  Those individuals who planned to make tax-generating gifts this year may want to consider doing so in early 2010 to take advantage of a potentially lower tax rate.

Additionally, because the generation-skipping tax is currently repealed, those with a desire to transfer assets to irrevocable trusts to benefit grandchildren may find now to be the right time to make generous gifts.

Keep in mind that with any planning ideas we are in a time of great uncertainty.  It is possible the estate and GST taxes may be reinstated retroactive to January 1, 2010, and we recommend that you call us to discuss any planning options that might be of interest to you.

We hope this letter has been helpful to you and we look forward to hearing from you if we may be of further assistance.

Yours truly,

HENSON & EFRON, P.A.

This letter does not provide a comprehensive statement of the law or proposed legislation and is meant as a general summary.  For information specific to you, please contact us.

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