No Federal Estate Tax in 2010

With the New Year rung in, the dust is settling on a unique scenario throughout the country - the elimination of the federal estate tax for 2010. On the surface that seems like great news, but persons with popular A-B trusts may experience unexpected negative consequences on anticipated distributions to heirs as rules in income tax laws have also changed.

How Did This Happen? Tax Act Background

A brief review of the law will help explain why this is so significant. The 2001 Tax Act signed into law by President George W. Bush, gradually reduced the maximum rate of the federal estate tax from 55% to 45%. It also gradually increased the amount of property that you could pass free of federal estate tax from $675,000 per person in 2001 to $3.5 million per person in 2009. That means that with basic estate planning, a married couple could pass up to $7 million free of federal estate tax, if they both died in 2009.

Then, in 2010 only, the 2001 Tax Act repeals the estate tax resulting in zero federal estate tax during this calendar year. Under the existing law, the estate tax returns again on January 1, 2011 - only at a much lower $1 million exemption and a higher maximum 55% tax rate. This strange "now it's gone, no it isn't" effect, is the result of a rule in Congress that attempts to limit budget deficits.

Paying for Estate Tax Repeal

To pay for this one-year vacation from the estate tax, Congress replaced the estate tax with an increased income tax. Before 2010, any assets that pass to someone when you die would be valued at fair market value at the date of death. Thus after death, when a surviving spouse or heirs sold any assets (like securities or a home) that had increased in value, they would not have to pay income tax on any of that growth that occurred during your life. (This is referred to as a "step-up in basis.") For many heirs, this means huge income tax savings, often tens of thousands of dollars or more.

But in 2010, property that passes at death does not automatically receive this step-up in basis. Instead, each individual has a limited amount of property that can be "stepped-up" in value at the time of death. Property that does not receive this step-up value will be subject to tax on all increase in value from the date you first acquired the property. This means that the property could be exposed to tens of thousands of dollars of income tax liability for your heirs.

Not surprisingly, these rules are convoluted and in many cases very different from the old law.

How You Are Affected?

This law can affect you in several ways. For married couples as well as single clients, we need to first make sure that your property will be divided according to your desires, and not dictated by Congress. For more than 50 years, it has been common to use what we refer to as "A-B Trusts" to maximize estate tax savings. Many, if not most, of our clients have this planning in place.

In 2010, when there is no estate tax, these formulas will not work. If a spouse is not your sole beneficiary, the existing formula could result in the disinheritance or substantial reduction of resources provided for the surviving spouse.

What Should You Do?

Contact an attorney from Day Ketterer's Estate Planning Group to review your estate plan, and make any changes that are necessary to ensure that your intended estate planning objectives are still met, and have not been substantially altered by Congress's actions. Moreover, we need to be sure that tax consequences are properly minimized, including confirming that your property is positioned to receive the maximum step-up in basis increase available under the current law.

Again, please note that your existing plan may generate unexpected and inappropriate consequences at the time of death, because of these tax changes. It is critical that you understand their impact and make appropriate adjustments, if necessary.

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