The Repeal of the Federal Estate Tax: What Does It Mean to You?

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Corporate & Finance Alert

January 5, 2010

As you may have heard, the Federal estate tax was repealed effective January 1, 2010. This repeal is expected to be temporary since, under current law, the Federal estate tax comes back to life in 2011. Prior to its repeal, the Federal estate tax exemption amount was $3,500,000 per individual, or $7,000,000 between spouses. This is the amount that an individual could pass to his or her descendants or intended heirs free of the Federal estate tax which, in 2009, had a maximum rate of 45%.

On January 1, 2011, the Federal estate tax will be resurrected with an exemption of $1,000,000 per individual and a maximum rate of 55%. Some members of Congress have indicated that there likely will be legislation in 2010 to reinstate the estate tax and even try to make it retroactive to January 1, 2010 – so, maybe it’s not really repealed after all. There could be constitutional challenges to any Congressional attempt to reinstate the estate tax retroactive to January 1, 2010, but we will have to wait and see what happens. In addition to the Federal estate tax repeal, the generation-skipping transfer tax (“GST tax”) was repealed on January 1, 2010 and is also scheduled to resurrect itself in 2011. The GST tax applies to certain distributions to grandchildren or more remote descendants.

What do you need to know?
If you are married and you and your spouse have current Wills or Living Trusts that create a family trust, or credit shelter trust, that is designed to be funded at death with the exemption from the Federal estate tax and also create a marital trust for the benefit of the surviving spouse, it may be uncertain how the terms of your existing documents will be interpreted while there is no estate tax. This same uncertainty applies whether or not you are married, if your Will or Living Trust has a portion of your estate equal to your unused GST tax exemption pass to grandchildren or a trust for their benefit. This uncertainty results because your current estate planning documents may contain terms which are phrased in terms of tax concepts, such as the estate tax exemption amount, marital deduction amount, or GST tax exemption amount and those tax concepts have now changed with the repeal of the Federal estate and GST tax.

Another important change that has occurred with the temporary repeal of the Federal estate tax relates to the income tax basis of assets a beneficiary inherits. Under prior law (2009 and prior), if someone died, the beneficiaries of a decedent’s estate inherited assets at a basis commonly referred to as the “stepped-up” basis – which was the fair market value of the assets at death. This tax rule no longer applies in 2010. Instead, if you die in 2010, your beneficiary will inherit any asset you owned at death at an amount equal to its original income tax cost basis – which could be much lower than the fair market value of the same asset at your death. While the new law allows an executor to allocate up to $1,300,000 to increase the basis of property a beneficiary inherits (or up to $3,000,000 for assets that pass to a surviving spouse), this allocation may not always increase the basis of the asset above its fair market value as of a decedent’s date of death. As a result, a beneficiary could be faced with paying a substantial capital gains tax if the beneficiary sells the inherited asset.

At this time, it is important for you to review your existing estate planning documents to address the concerns raised by the new law and determine if changes need to be made. For more information or assistance, please contact Rita M. Danylchuk of the Gibbons trusts and estates team.