Sunday, January 31, 2010
TRUSTS AND ESTATES ALERT
As you may have read in recent weeks, 2010 has brought sweeping changes in the federal estate tax and generation-skipping tax laws. You have no doubt read about some of these changes. While the effect and longevity of the changes are currently uncertain, this bulletin will summarize the more important changes for your consideration and will then highlight two particular planning concerns.
Brief Overview of Changes
- Due to Congressional inaction near the end of 2009, the federal estate tax and generation-skipping tax have been repealed, at least temporarily, for 2010. This means that there is a possibility that there will be no federal estate tax or generation-skipping tax imposed on the estate of an individual who dies in 2010.
- Unless Congress acts in 2010, both the federal estate tax and the generation-skipping tax are scheduled to be reinstated in 2011 with an estate tax exemption of only $1 million and a top tax rate of 55%. This would represent a return to the system that we had in 2001.
- There is great uncertainty as to when and how these taxes will actually be reinstated. For example, Congress may or may not act in the foreseeable future to reinstate them. Whenever Congress does act, it may or may not reinstate the $3.5 million estate tax exemption and top 45% rate that prevailed in 2009. Moreover, it is unclear whether Congress will attempt to reinstate the taxes retroactively to January 1, 2010, and it is further unclear whether Congress could constitutionally do so.
- The gift tax has not been repealed, but the tax rate has been reduced from 45% to 35% on gifts that exceed the $1 million lifetime gift tax exemption. The gift tax annual exclusion remains at $13,000 per donee in 2010.
- The "stepped-up-basis rule" -- whereby the income tax basis of inherited property is redetermined at fair market value as of the date of death -- has been replaced by a complex system of "carryover basis." This will put a premium on having good historical records of what you paid to purchase your assets. A carryover basis regime was previously enacted in 1976 but was repealed after a few years because of its complexity. Thus, there is a real possibility that carryover basis might again have a short life.
The foregoing changes could have unintended effects on the estate plans of individuals who die while the estate tax and generation-skipping tax are repealed. We want to highlight two of the more typical potential effects:
- (1)A common estate planning approach for married couples has been to create at the first death both a marital gift for the benefit of the surviving spouse (either outright or in trust) and a trust, commonly known as a "family trust," to be funded with assets having a value equal to the former estate tax exemption -- i.e. $3.5 million in 2009. The family trust might be written so that it would benefit either the surviving spouse, the surviving spouse and descendants, or just the descendants. To optimize the tax effectiveness of this planning approach, a formula clause has typically been used, which refers to technical tax concepts now temporarily repealed. If a married client with this plan were to die while the estate tax is repealed, it is likely that nothing would pass into the family trust and that the client's entire residuary estate would pass to or for the benefit of the surviving spouse. In most cases this inadvertent elimination of the family trust should not present a problem, as it may be acceptable to have the spouse receive the entire estate in one trust, or the inadvertent elimination of the family trust could be cured by the surviving spouse's disclaiming assets into the family trust following the death of the first spouse. In some cases, however, the surviving spouse might be unwilling or unable to disclaim or simply unaware of this possibility.
- (2)The repeal of the generation-skipping tax might also cause unintended consequences in the estate plans of clients who have opted to include this more complex planning. For example, if a client's Will devises an amount "equal to my available GST exemption" either directly to grandchildren or to a trust that will ultimately pass to grandchildren, it is possible that nothing might pass under this devise if the client were to die during the repeal period.
- A valid retroactive reinstatement of the estate tax and the generation-skipping tax would eliminate the foregoing concerns. However, we do not know exactly when and whether that might happen.
Under the circumstances, we would encourage you to review your estate planning documents and asset holdings (and your basis therein) and consider whether any unintended consequence might result from an untimely death in 2010. At the same time, you might want to consider whether your documents otherwise need updating.
Please feel free to contact one of our estate planning attorneys if you would like for us to review your situation with you.