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This is the first of a series of articles involving issues that may impact your estate and financial plans. We hope you find the information useful and that you will provide us with your questions, comments, and any topics you would like us to cover in the future.
2010 ESTATE PLAN CHECKUP
1. WHAT YOU NEED TO KNOW NOW REGARDING THE 2010 CHANGES IN FEDERAL ESTATE TAX
- Both the estate tax and the generation-skipping transfer tax (on assets given to grandchildren) were repealed at the end of 2009.
- If nothing is done, both taxes are scheduled to return in 2011 at the unfavorable rates that applied 10 years ago. The amount that is exempt from each of these taxes will then be $1 million, and the tax on the balance will be as much as 55 percent.
- There is still a gift tax if you give away more than $1 million during your lifetime, but the tax rate has been reduced from the 45 percent in effect in 2001 to 35 percent.
- Until 2011, or there is a change in the law, heirs will have to use the acquisition cost (COST BASIS) for an asset when computing their tax liability, instead of the value upon the owner’s death (STEPPED UP BASIS). This change of “COST BASIS” instead of “STEPPED UP BASIS could be very expensive and difficult for heirs.
2. ESTATE TAX LEGISLATION
Congress passed legislation in 2001 gradually eliminating the estate tax rate and amount taxable for those who died through 2010. In 2010 the estate tax is zero, but for only one year. Since the 2001 law had a sunset provision, 2011 estate taxes will revert back to the 2001 levels, unless Congress acts sometime between now and the end of 2010. So in 2011, the Federal Estate Tax will again apply to amounts over $1 million being taxed at a rate of as high as 55% for estates where a spouse is not the beneficiary.
Congress has expressed its dismay at the lack of an estate tax in 2010 and has vowed to address this situation. It is not unreasonable to expect that it will make changes to the estate tax law retroactive to January 1, 2010.
3. LOSS OF THE STEPPED UP BASIS AT DEATH
At first glance, the 2010 estate tax holiday appears to be very good news only for heirs of terminal rich individuals — and of little consequence to everyone else. However, by letting the tax lapse, Congress has created a number of unintended consequences and increased the chances that heirs will owe tax as a result of an inheritance.
Until December 31, 2009, the tax basis of the decedent’s assets was generally "stepped up" to fair market value at the time of the decedent’s date of death and the heir received the asset at that "stepped up" basis. Thus, an heir would treat the asset for tax purposes as if it were acquired as of the date of death of the decedent and subsequent gain or loss on sale of the asset by the heir used "stepped up" basis as the cost basis in calculating the gain or loss on sale. The process was very simple and applied to all inherited assets no matter how small or large the estate.
In 2010, however, it became much more complex. Now in 2010 since there is no longer an estate tax, the basis of a decedent’s assets, on an asset-by-asset basis, can only be stepped up to a total $1.3 million without incurring tax consequences. Assets inherited by a surviving spouse, however may be stepped up to a total of $3 million.
In order to determine the cost basis for the heir, records must now be produced that reflect the acquisition price of securities held by the decedent. It will be very likely that the IRS will determine basis not readily ascertainable to be zero. This would force most heirs with estates over $1.3 million to produce complete records of the acquisition cost of each of securities held. These records must then be retained by the heirs receiving the inheritance to avoid being unnecessarily taxed. This is a significant bookkeeping nightmare.
4. CLAUSES USED IN PAST DOCUMENT TO SAVE TAXES COULD NOW EFFECTIVELY DISINHERIT THE SURVIVING SPOUSE
Many wills and trusts were written on assumptions that made sense in prior years. However, with the changes in the estate tax law certain clauses in those estates and wills could result in the reduction or entire elimination of the interest of a surviving spouse.
For example - in order to minimize estate taxes, many wills and trusts were drafted in a manner that would pass only the amount to the surviving spouse that exceeded the amount that could be transferred to other beneficiaries free of estate taxes. Historically that amount ranged from $1 million in 2001 to $3 million in 2009. So the surviving spouse would receive the proceeds of the estate in excess of the $1 million to $3 million nontaxable portion of the estate, depending on the year of death of his/her spouse. Since in 2010, under the current law, the entire estate can pass to heirs free of estate tax this sort of clause could mean the surviving spouse would get nothing because there is no value in the estate that is subject to estate tax.
Thus depending on how a clause is worded, it is now possible that a substantial portion, if not the entire estate, of the first spouse to die could pass to heirs other than the surviving spouse.
5. REVIEW YOUR ESTATE AND FINANCIAL PLANS
There are a variety of potential solutions that you should discuss with your legal counsel and/or accountant so that your individual circumstances are appropriately addressed. Now is a good time to review your will and trust documents. We also recommend that you review your will and trust periodically to ensure they continue to reflect your intentions.
Although I have listed some serious potential issues facing us, there are also solutions available. We will be happy to assist you.
Richard B. Conger, ESQ - Chief Trust Officer