In 2001, the Federal Government passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”). This tax bill provided for the gradual increase of your federal estate tax exemption amount from $675,000 in 2001 to $3.5 million in 2009, and a decrease of the tax rate for remaining assets above the exemption amount subject to federal estate tax from 55% or more to 45%. This is followed by a repeal of the federal estate tax for one year during the year 2010, then a return to an exemption amount of $1 million per individual in 2011 and beyond at a tax rate of 55% or more on assets above the exemption amount.
Most of the planning world anticipated that Congress would act sometime prior to 2010 to give this issue some certainty. We have now reached 2010, and as of yet Congress has not acted to give us any permanent direction in this area. As a result, there is substantial confusion as to what we can expect the federal estate tax law (as well as federal gift tax and federal generation skipping transfer tax) to be going forward from 2010.
Despite this current time of confusion and waiting to see how Congress will respond, this column summarizes where we currently stand and what we can expect.
There are essentially three potential planning scenarios based on Congress’s actions during 2010:
Congress acts during 2010 to give us some permanent estate tax numbers, and the law applies retroactively to January 1, 2010; or
Congress acts during 2010 to give us some permanent estate tax numbers, and the law does NOT apply retroactively, or the retroactive portion of the law is held to be unconstitutional and the retroactive feature does not apply; or
Congress does not act at all during 2010, in which case we would return to a $1 million federal estate tax exemption amount per person at a tax rate of 55% or more on the assets that are not exempt.
Because of the Congressional calendar, we can be more precise in our guessing about Congressional action. Congress could act before summer recess preceding the campaign season. Summer recess will start about August 8. Many believe it is unlikely that Congress will act before recess and that they will more likely act after returning following Labor Day. This would mean that the next likely time period for Congressional action would be after the election. Some prominent planners predict Congress will allow the 2001 tax bill to expire, which will restore most of the tax increases prior to 2001 and return the exemption amount to $1 million. This could push any Congressional action on estate tax to the beginning of 2011.
Secondly, this leads to three possible different results, depending on Congress’s activity or inactivity, as it affects federal estate tax exemption amounts and taxation rates:
The $3.5 million federal estate tax exemption rate from 2009 is extended and continues to apply, and amounts above $3.5 million are taxed at a 45% rate, which is also the 2009 rate; or
We see an increased federal estate tax exemption amount and a decreased tax rate for amounts above the exemption amount. For example, this could be a $5 million exemption amount at a 35% tax rate, or something similar. Additionally, an increased exemption amount and a decreased tax rate like this could be made immediately effective, or could be gradually phased in over several years; or Upon a failure of Congress to act, we would return in 2011 to a $1 million federal estate tax exemption amount and a tax rate of 55% or more on amounts above the exemption amount.
In addition, other, more intricate changes have also come into being during the year 2010 under the EGTRRA tax act. These include issues like a decreased gift tax taxation rate, changes in the generation skipping transfer tax system and income tax changes from a step-up in basis on assets included in your estate to what is known as a “modified carry-over basis” system, etc.
Finally, a number of additional specific issues and challenges make it even more crucial to address how the current uncertainty in 2010 affects estate planning. Some of these issues, though there are certainly others to consider, include:
- Challenges created by the quality of the legal drafting itself, including the presence or absence of language that addresses these issues.
- Challenges faced by “blended families” and new spouses. Remember Thor and Bambi.
- Challenges created by how your charitable planning and goals are affected by the current 2010 situation.
- Challenges presented by estate planning documents that leave certain assets in certain ways to grandchildren or more remote beneficiaries and potentially create confusion in the generation skipping transfer tax area.
- Challenges created by estate planning documents that were created a number of years ago and have not been proactively reviewed and updated to address the unique changes of the year 2010 and beyond.
Here is an example of the problem. Assume your estate planner wrote an A/B trust (i.e., credit shelter or family trust plus marital trust) for you and your new spouse, Thor or Bambi in 2002. Assume further that the formula clause provides that upon your death, an amount sufficient to provide no federal estate tax will go into your marital trust for the benefit of Thor or Bambi and the balance into your family (credit shelter) trust for the benefit of your children from your first marriage. If you died in 2010, Thor or Bambi could receive nothing in the marital trust, with everything instead going for the benefit of your children in the family trust. This is not how your plan was originally drafted.
You might also see similar results with formulas making gifts to charity.
How do you know if your estate planning documents are up to date? Have a competent estate planning legal specialist review your estate planning documents to see if your wishes are still going to be followed. When you are gone, you want to make sure that you give what you have to whom you want, when you want, the way you want.
By: Matthew M. Wallace, CPS, JD
Published edited April 25, 2010 in The Times Herald newspaper, Port Huron, Michigan as: Confusion remains about future of estate tax law