Newsletter: January 2010

January 19, 2010

In this issue: Estate Tax Planning for 2010 and Beyond

This Special Edition of the Smith and Condeni LLP Newsletter focuses on the current uncertainty with regard to the future of federal estate tax legislation and reform, and what this means for individuals with estate plans already in place, as well as for persons currently contemplating their need for estate planning.

History of Estate Tax Repeal

Nine years ago, Congress enacted the Economic Growth and Tax Relief Reconciliation of 2001 (EGTRRA) to repeal the federal estate tax for individuals dying in 2010, and then to bring that tax back under more stringent terms for those dying in subsequent years. Most commentators believed that the current Congress would undo the impending repeal and permanently, or at least temporarily, keep the estate tax at its 2009 levels ($3,500,000 per person exemption with a top estate tax rate of 45%). However, with the controversial battle over healthcare reform and other “hot button” issues taking priority, Congress was unable to pass an estate tax bill before the end of the 2009 calendar year.

Provisions of Estate Tax Repeal

Due to the sunset provisions of EGTRRA, as of January 1, 2010, there is no federal estate tax or generation skipping transfer (GST) tax. This does not necessarily mean, however, that taxes will be lowered for the heirs of individuals dying in 2010, because the 2010 repeal includes changes to the income tax basis rules for property acquired from a decedent. As a result of those income tax changes, some heirs could potentially incur higher combined estate and income tax costs if a family member dies in 2010. In addition, there remains a 35% gift tax on gifts in excess of $1,000,000 per individual ($2,000,000 for married couples), though the $13,000 annual exclusion gifting ability of individuals ($26,000 for married couples) also remains intact.

History of Estate Tax Repeal

Nine years ago, Congress enacted the Economic Growth and Tax Relief Reconciliation of 2001 (EGTRRA) to repeal the federal estate tax for individuals dying in 2010, and then to bring that tax back under more stringent terms for those dying in subsequent years. Most commentators believed that the current Congress would undo the impending repeal and permanently, or at least temporarily, keep the estate tax at its 2009 levels ($3,500,000 per person exemption with a top estate tax rate of 45%). However, with the controversial battle over healthcare reform and other “hot button” issues taking priority, Congress was unable to pass an estate tax bill before the end of the 2009 calendar year.

Future Legislative Action

While Congress was unable to address these estate tax issues before the end of 2009, it seems likely that some legislative action will be taken in 2010. As you may recall, the U.S. House of Representatives approved H.R. 4154 (the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009) on December 3, 2009, which would bring back the 2009 estate, gift and GST tax laws and make those laws permanent. The Senate, however, has yet to act on this measure.

Whether for or against the repeal, most legislators would not want to see the more stringent post-2010 rules that would come into effect in 2011 under the sunset provisions of EGTRRA, so many commentators believe that a compromise will be reached by the Congress in 2010.

We note, however, that the current state of federal estate tax legislation has proven again that nothing on this matter is certain, nor can any action in 2010 be guaranteed; recall that no one imagined that the 2010 repeal under EGTRRA’s sunset provisions would actually come to fruition! Another point that remains unclear is whether, if action were taken in 2010, legislation regarding the estate tax could be given retroactive effect. While some Senate leaders have vowed to make a retroactive “fix” in early 2010, many tax experts suggest that a retroactive tax increase would not pass constitutional muster.

Yes, You Will Still Need an Estate Plan

As the federal estate tax exemption increased under EGTRRA, the need for estate planning and the volume of estate planning work being done did not decline from previous years. Even in 2009, when the exemption hit its peak of $3,500,000 and, according to some statistics, only about 0.2% of estates were subject to federal estate taxes, people continued to implement estate plans.

The lack of a decline in estate planning can be attributed to the fact that even those individuals without a need for estate tax planning still have certain financial and personal matters that need to be addressed in an estate plan: How will their health and financial well-being be protected in the event of their incapacity? What will happen to their business in the event of their death? How can they protect a child who does not know how to handle money, is in a bad marriage or has a high-risk profession?

That is not to say that there are not individuals for whom estate tax planning is still relevant, especially considering the $1,000,000 federal estate tax exemption that is scheduled to return in 2011 under current law unless Congress passes legislation to change this. Also bear in mind that the 2010 repeal does not affect the Ohio estate tax, which continues to apply to all estates in excess of $338,333.

What to do with Existing Estate Plans

Most estate plans will likely not be adversely affected by the federal estate tax repeal, though it may be prudent to have those plans reviewed to err on the side of caution. This is particularly true for individuals with so-called “A-B” trust arrangements where there are different beneficiaries of the trusts (for example, in a second marriage situation where the spouse is beneficiary of the marital trust and the children are beneficiaries of the credit shelter trust). Because many of these trust arrangements rely on formulas that take into consideration the applicable federal estate tax exemption in order to allocate assets between the trusts, the absence of a definable exemption amount may cause unforeseen consequences.

Again, while it is expected that the federal estate tax will return in 2011 with an exemption of $3,500,000 and top tax rate of 45%, recent events in this area have demonstrated that in the current political and economic climate, nothing can be guaranteed. Notwithstanding this uncertainty, though, estate planning for individuals, no matter how great or small their tax planning needs may be, should still be undertaken. Moreover, while most existing estate plans will likely not require modification, individuals with questions or concerns regarding those plans will want to meet with their advisors to determine what, if any, adjustments should be made.