DEATH AND TAXES

They say that the only two things you can count on are death and taxes.  No more.  The federal death tax has disappeared for 2010; and there are devastating changes coming in 2011, along with plenty of chaos in the meantime.   This situation affects many of you to a significant degree.  This is an effort to briefly apprise you of the current situation and the likely shape of the near future.

The federal death tax scheme that we have become familiar with over the past decade was enacted in 2001 as the Economic Growth and Taxpayer Relief Reconciliation Act (the “Act”).  Under the Act, the existing $675,000.00 exemption amount was increased over time, eventually reaching $3.5 million in 2009; and the existing 55% maximum marginal rate was reduced, eventually getting down to 45% in 2009.  When the Act was passed in 2001, it also contained provisions that automatically repealed both the federal estate tax and generation-skipping transfer (GST) tax (although not the gift tax) in 2010.  Finally, the Act provided that in 2011, the federal estate and GST taxes will come back into effect, with a horribly low $1 million exemption and an awful 55% maximum marginal rate, with a 5% add-on for certain large estates.  This means that anyone who has a combined estate with his/her spouse - counting insurance policies, retirement plans, real estate and everything else - of only $1 million will likely be exposed to the confiscatory federal death tax in 2011.

Nearly all commentators believed that Congress would never allow the 2010 repeal to happen because of the billions in lost tax revenue in an environment of vast government give-aways and deficits.  Also, it was felt that the chaos caused by moving to a modified carry-over basis (see below for discussion) would never be allowed to take place.  The commentators were wrong.  To everyone’s utter amazement, Congress was unable to reach consensus on a new federal death tax law or even on a short-term extension of the current law.  Congress did nothing and allowed the repeal and carryover basis to become law.

After that shocking lack of action by Congress, most commentators believed that Congress would certainly enact a new federal death tax law prior to the end of September of 2010 - before the federal death tax return would be due for someone dying on January 1, 2010 or thereafter.  It was felt, once again, that the government could not afford to lose the revenue from this tax or allow the economic chaos caused by carry-over basis.   Of course, any new law would have to be applied retroactively, which would certainly cause large estates that were subjected to the retroactive tax to challenge the constitutionally of that retroactive application.  As it happens, Texas multi-billionaire Don Duncan died in March of 2010; and George Steinbrenner died in July of 2010.  Each of those estates, with billions in tax at stake, would certainly raise constitutional issues.  Well, the commentators were wrong again.  Congress has not passed such a law, and, given that it is now August, Congress seems unlikely to do so.

Commentators also felt that the government could not, in all moral conscience, allow the 2011 law to come into effect automatically, because it will subject the estates of most middle to upper middle class Americans to the confiscatory 55% federal death tax that was intended to be imposed only on the truly wealthy.  The commentators were wrong yet again.  It seems likely that, by inaction, Congress will allow the 2011 law to come into effect. 

What could happen at this point?

1. Congress could do nothing, either intentionally or due to dysfunction.  This would allow the federal estate tax and GST tax to be reinstated in 2011 with an estate tax exclusion amount of $1,000,000 and a 55% maximum marginal rate, plus a 5% add-on for certain large estates; and the GST tax exemption amount would be an inflation indexed amount - probably a little over $1,340,000, which would have been the indexed amount in 2010.  I think this is by far the most likely outcome because it raises massive amounts of tax revenue and does not require any affirmative action by Congress – most especially it does not require an active, unpopular vote in favor of new taxes.  It will also confiscate the life-long efforts of many small business owners, farmers and just regular working people who have saved and lived conservatively.   The fact that estates of the super-wealthy, like Duncan and Steinbrenner, will escape tax entirely because they happened to die in 2010 makes this an even more bitter pill to swallow.  I have even heard that some super-wealthy people who are terminally ill but not likely to die this year plan to go to Sweden for assisted suicide late in 2010 so their families can save billions in death taxes.

2. Congress could pass some sort of legislation and attempt to impose it retroactively to January 1, 2010.  At this point, that seems unlikely for a number of reasons, including the fact that a constitutional challenge by the estates of decedents dying in 2010 would be virtually certain.  Further, the Statutory Pay-As-You-Go Act, enacted in February 2010, makes any reduced federal death tax scheme unlikely because it requires that changes to the estate tax beyond a two-year extension of 2009 law must be fully offset by cuts in programs or by revenue increases. 

3. Congress could pass some sort of legislation and not attempt to impose it retroactively.  Again, this seems unlikely for the reasons stated above.

So, where are we now?

1. The federal estate tax and GST tax are both repealed for 2010.   There is still a gift tax in 2010 but with a maximum marginal rate of 35% (instead of 55%) and a $1 million exemption amount.  The annual exclusion for gift tax is still $13,000.00 per year per person.

2. Modified carryover basis is in effect.  An heir will receive an income tax basis in inherited assets equal to the lesser of the decedent’s adjusted basis for the asset, or the fair market value of the asset at the time of the decedent’s death.  Elections exist allowing someone (unclear whether it is the executor or the recipient) to increase the basis of the property received from a decedent’s estate by up to $1.3 million of unrealized appreciation and there is an additional  $3 million of basis step-up potentially available for unrealized appreciation on property passing to a surviving spouse.   The IRS was surprised by Congress’ lack of action along with everyone else, and the Service has now commenced work on creating an informational return that will need to be filed by estates dealing with these basis issues and allocation issues.  

What should you be doing about all of this?

1. First and foremost, be keenly aware of these issues and pay close attention to both the state of the law and your total asset values as we approach 2011!  If the pre-Act tax comes back into effect in 2011 and you do nothing to deal with this, your family could well be subjected to a devastating tax and that might have been reduced or even avoided by proper and timely planning.  Even if Congress does somehow act and pass a new law, you will want to review your estate plan and your asset valuation and allocation in light of that law.

2. Since it now appears that there will be no federal death tax for 2010, any tax-oriented estate planning documents you have in place could be wildly inappropriate if you should die in 2010.

1. If your Will or revocable trust contains a “bypass trust” or a unified credit shelter gift to the kids, or anything similar and/or a marital gift that is determined by a formula clause such as “I give my spouse the least amount necessary so that there is no federal death tax imposed on my estate”, the results, if you die when there is no federal death tax, will be to give nothing whatsoever to the spouse and for your entire estate to pass directly to the bypass trust or perhaps the kids.  Very likely this is not your intended result.  If you have tax-oriented estate planning documents and have any concern whatsoever that you might die in 2010, new documents should be prepared for the remainder of 2010, now that it has become reasonably likely that there will be no federal death tax in 2010.

2. If your Will or revocable trust provided for generation skipping transfers and says, for example, that “an amount protected from GST tax” is to be paid to a trust for your grandchildren, then your entire estate could pass to your grandchildren because there is no GST tax for people dying in 2010.  Again, this is likely not your intended result and such documents would need to be changed for the remainder of 2010 if you have any concern that you might die in 2010.

3. If your estate planning documents contemplate a zero-tax estate – for example, by giving your kids the maximum amount protected by the exemption amount and the rest to charity, if you should die in 2010, nothing would go to the kids because there is no exemption amount and 100% of your estate would pass to charity.  Once again, such documents would need to be changed for the remainder of 2010 if you have any concern at all that you might die in 2010.

3. Since the federal gift tax rate is at a relatively low maximum marginal rate of 35%, you might consider making taxable gifts in 2010.  Such gifts could be “leveraged” through the usual techniques of discounting for minority interest and lack of marketability and/or though interposing a charitable interest. 

4. Since there is no GST tax in 2010, you could make gifts such as those described above to grandchildren in 2010 without the usual concerns about the truly terrible GST flat tax of 50% on top of the regular 55% estate tax.  Of course, there is a risk that Congress will attempt to retroactively impose a GST tax on 2010 transfers.  So, any such gift should contain a give-back provision if GST is enacted for 2010, but, as each day goes by, that seems more unlikely.

5. You should very carefully review your asset allocation – who owns what as between yourself and your spouse.  Assets that were placed into separate ownership for pre-2010 death tax planning purposes may not need to be so held in 2010 and may cause an unnecessary probate expense.  Note, however, that if the 2011 law goes into effect, asset allocation will need to be reviewed again as part of the planning to deal with that truly terrible tax exposure.

CAVEAT:  THIS IS A MUCH OVER-SIMPLIFIED GENERAL NEWSLETTER AND SHOULD NOT BE RELIED UPON AS LEGAL ADVICE.  THE DEATH TAX LAWS ARE EXTREMELY COMPLEX AND EACH FAMILY’S SITUATION IS DIFFERENT.   A MISTAKE IN PLANNING FOR THE APPLICATION OF THESE LAWS TO YOUR PARTICULAR SITUATION OR INACTION ON YOUR PART IN SEEKING ADVICE ON HOW THESE LAWS MAY AFFECT YOU COULD LEAD TO EXTREMELY HIGH TAX EXPOSURE FOR YOUR FAMILY.

            I hope you found this information helpful.  If you have questions about any of this, please feel free to contact me or any of the attorneys at Hartman Shurr and we will do our best to provide you with clear answers.

Cordially,
Gregory C. Hartman
Hartman Shurr
1100 Berkshire Blvd, Suite 301
Wyomissing, PA 19610
(610) 779-0772