Beware of Unintended Consequences of the Estate Tax Repeal
April 10, 2010
As we forecast in LP's December 2009 DataPoint, the federal estate tax and generation-skipping transfer (GST) tax were repealed on January 1, 2010. The federal gift tax remains in effect, but the tax rate has dropped to 35 percent from 45 percent. The estate tax and GST tax will be reinstated on January 1, 2011, with a federal estate tax exemption of only $1 million and a maximum tax rate of 55 percent (compared with the 2009 exemption level of $3.5 million and tax rate of 45 percent). While Congress may act this year to reinstate the estate and GST taxes (potentially even retroactively to January 1 of this year), there is at least a possibility that 2010 will be a year with no estate or GST taxes.
With the temporary repeal of the federal estate tax, taxpayers have lost the step-up" in income tax basis for their assets that previously occurred on death. Family members now may be required to pay capital gains tax on the sale of inherited assets. Under a new "carry-over basis" regime, the income tax basis for determining gain or loss on the sale of capital assets acquired from a decedent will match the decedent's basis in those assets prior to death, or will equal the date of death fair market value of the assets, if lower. However, the executor of an estate may allocate $1.3 million of basis to appreciated assets and an additional $3 million to increase the basis of assets passing to a surviving spouse. Many estate planning documents were drafted with an assumption that the federal estate tax and GST tax regimes would exist upon a person's death. Some estate planning documents may contain provisions that specifically reference those taxes. In certain situations, the meaning of those provisions may now be unclear.
If a person dies while there is no estate or GST tax, or when the exemptions or rates differ significantly from those anticipated when the plan was drafted, unintended consequences may result. An estate plan drafted to maximize estate tax exemptions may not be designed to take full advantage of the $3 million basis increase now allowed for assets passing to a surviving spouse.
Many people in the estate planning community expect Congress to act this year to reenact the estate tax and GST tax, potentially even retroactively. Even if Congress takes no action, most of the potential issues that could arise from the temporary repeal of estate and GST taxes would be an issue only for someone who dies this year.
Immediate revision of every estate plan is not warranted. However, if the estate plan has not been reviewed in the last eight years, if it includes gifts to grandchildren, or if it contains specific provisions for children or other family members as a result of a second marriage, it may be necessary to revise the plan to ensure that the specific goals are achieved. If Congress takes no action this year on gift, estate and GST taxes, there also may be tax planning opportunities only available in 2010.