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The Current Uncertain Estate Tax Environment

By Ron Alcutt, McGuireWoods, LLP Private Wealth Services Group

The 2010 Estate Tax Earthquake

Because Congress did not act in 2009 to preserve the federal estate and generation-skipping transfer (“GST”) taxes in 2010, the federal estate, gift, and GST taxes, which are sometimes collectively referred to as transfer taxes, have changed greatly from what they were in 2009.  As a result of the provisions of the 2001 Tax Act, the official title of which is the Economic Growth and Tax Relief Reconciliation Act of 2001 and which is sometimes referred to as “EGTRRA,” the estate and GST taxes have been repealed for one year while the gift tax remains in place with a $1 million exemption and 35% maximum rate and a “modified carryover basis” regime has been implemented to generally deny a step-up in basis of appreciated assets at death.  Unless Congress acts, the estate, gift, and GST taxes as they existed before 2002 will be reinstated in 2011 with a 55% rate (with a 5% surcharge on estates or cumulative gifts between $10 million and $17.184 million), a $1 million exemption for lifetime and testamentary transfers, and a $1 million exemption from GST tax (as indexed for inflation since 1999).  Because of this changed and unpredictable environment, clients and their advisors now face significant uncertainty in planning the gratuitous transfer of assets given the current state of transfer tax exemptions and rates.

What Will Congress Do?

It is impossible in this time of increased polarization and partisanship in Congress to predict if and when Congress will act to eliminate the uncertainty and disparity in the transfer tax laws.  If Congress acts, it is impossible to predict the effective date of the legislation, specifically whether the legislation will be retroactive to January 1, 2010 or effective as of the date of introduction or enactment.  If Congress acts and the legislation is retroactive, there undoubtedly will be a constitutional challenge to the retroactive application of the legislation.  Predicting the outcome of such a challenge is impossible.

Congressional action could involve any of the following possibilities:

  • Congress could enact transfer tax legislation, effective retroactively to January 1 2010, and either extend the 2009 transfer tax rates and exemptions or enact new rates and exemptions.
  • Congress could enact transfer tax legislation, effective as of the date of enactment, introduction, or some other action, and either extend the 2009 transfer tax rates and exemptions or enact new rates and exemptions.
  • Congress could continue the deadlock and not enact any legislation so the above transfer tax rates and exemptions will remain in place in 2010 and 2011 and beyond.

What Must We Do? Review of Estate Plans

Congress’s inaction may mean that some estate plans no longer meet the client’s objectives and goals.  In particular plans based on formulas or decisions tied to transfer taxes may be significantly impacted by the current state of flux.  For example, if a married client directs in the client’s will or trust that property equal to the estate tax exemption is distributed to the client’s children to the exclusion of the client’s spouse or that property equal to the GST tax exemption is distributed to the client’s grandchildren, the disposition of the client’s assets will vary significantly depending on the year of the client’s death and whether and in what manner Congress acts.

Also, many wealthy individuals have estate plans that use charitable gifts or techniques, such as charitable reminder trusts or charitable lead trusts that are designed to take advantage of the federal estate tax charitable deduction with the intention of lowering or eliminating the estate tax associated with a particular vehicle or plan.

There are other situations where a client’s estate plan will no longer accomplish the client’s estate planning objectives depending on when and how Congress acts.  Accordingly, clients and their advisors should review their estate planning documents to determine whether changes are in order or necessary to accomplish the client’s planning objectives.  Also, clients should monitor activity in Congress to see if Congress quickly clears up this mess and thereby eliminates the need for changes.

If Congress fails to act quickly and there is a carryover basis regime for part or all of 2010, estate plans must be reviewed to make sure that adequate provisions have been or are made to take advantage of the adjustments available to reduce the impact on a decedent’s estate because the appreciated assets it holds no longer receive a step-up in basis to the fair market value on the date of death.

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