New tax law turns 2010 into `a great year to die'

The Economic Growth and Recovery Act of 2001, intended to repeal the federal estate tax, may turn out to be one of the most exciting and thought-provoking pieces of legislation to be enacted in years -- unfortunately, for all the wrong reasons.

To begin with, the federal estate tax is repealed for one year only, 2010. Yes, you read that correctly. If you, a loved one, or ol' rich Uncle Joe are not fortunate enough to die in 2010, many benefits of the act probably won't apply to you.

Generally speaking, the federal estate tax limits the amount people can pass tax-free to their heirs, other than a spouse. Prior to the act, the amount one could pass was $675,000 per person -- the "exclusion" amount -- and the maximum estate tax rate was 55 percent. A person may pass an unlimited amount to his or her spouse.

Under the new act, the federal estate tax is repealed after Dec. 31, 2009. The act also increases the exclusion amount and decreases the maximum estate tax rate in increments until its repeal in 2010. In 2011, the federal estate tax is reinstated.

The act does not repeal the federal gift tax, however. Beginning Jan. 1, 2002, the gift tax exemption, which mirrored the estate tax exemption, will be increased to $1 million and the gift tax rate will be identical to the estate tax rate. After Dec. 31, 2009, the maximum gift tax rate will be 35 percent under the act.

At first blush, the act appears to be a savior for millions of wealthy individuals who would otherwise be subject to the estate tax at their deaths. This may be true, but one had better plan his or her death in 2010 to be safe, because under a very complicated set of rules known as the "sunset" provisions, enacted under the Congressional Budget Act of 1974, the entire federal estate and gift tax structure returns as of Jan. 1, 2011.

So, if you die in 2011, you had better hope Congress has addressed the issue again.

Obviously, for the very wealthy, there will be an enormous incentive to last until Jan. 1, 2010, yet still die before Dec. 31, 2010.

An interesting side note to the act was the way Congress and the President single-handedly removed billions of dollars of income from the state government coffers, including Texas.

The federal estate and gift tax worked hand-in-hand with each state's individual estate and gift tax system. Because there is a dollar for dollar federal credit allowed for estate taxes paid to states, many were unaware of this union. Most states, including Texas, have used this credit to create a simple estate tax system by taxing estates in the amount of the maximum allowable federal credit, known as a "sponge" tax.

Under the new act, the state death tax credit is reduced until it is completely repealed in 2005. The credit is to be replaced with a deduction available for state estate taxes paid. As the state death tax credit is gradually phased out and the estate tax is repealed, states will lose substantial revenue unless they substantially overhaul their estate tax systems. If they do, the potential savings from repeal will be reduced.

One of the greatest headache-inducing provisions of the act is the repeal of the existing step-up in basis rule.

Currently, and until Dec. 31, 2009, upon a person's death, beneficiaries who receive property are entitled to a step-up -- or step-down -- in basis in the property to its current fair market value. Recipients of property after Dec. 31, 2009, generally will take a basis equal to the fair market value of the property or the decedent's adjusted basis, whichever is less. The main consequence of the loss of the basis step-up is detailed records of original cost basis will be required.

Certain adjustments and exceptions to the new basis rules will apply.

Every taxable estate will be permitted a basis increase up to $1.3 million. Additionally, for "qualified spousal property" -- property transferred outright to the spouse -- or qualified terminable interest property, the surviving spouse will receive an additional $3 million basis step-up. The new basis step-up rules are certain to cause much angst to executors of estates greater than $1.3 million, as the executors will be charged with allocating this additional basis to the assets of the estate. Disputes regarding the allocation of basis are a virtual certainty -- it then becomes imperative for wills and revocable/living trusts to address this issue.

Federal estate and gift tax planning, already quite complex, has been made even more complicated under the act. How does one plan for repeal in 2010 knowing the current federal estate and gift tax scheme may well be reinstated in 2011?

Most experts agree the act will be revisited, but have absolutely no idea what the future holds. As the act was predicated on certain budgetary surpluses -- already falling short -- a complete repeal of the federal estate tax seems unlikely. The general consensus among estate planners is the exemption levels will eventually shake out between $2 million and $2.5 million.

Estate tax planning will become much more individualized as plans will differ widely based upon the client's situation.

For example, an elderly person in poor health, who cannot expect to live to see the benefits of the increased exemption or repeal, will opt to use current techniques to reduce potential estate taxation, as opposed to a younger healthy person who may be able to afford postponing some transfers.

Current advance planning techniques such as family limited partnerships and grantor retained annuity trusts will remain viable alternatives, but retaining control at the donor/grantor's level will be more important than ever.

As exemption levels increase, estate plans will need to be reviewed to ensure the goals and desires of the client are met.

Need for estate planning will not disappear with the repeal of the federal estate tax, although estate planning is frequently tax-motivated.

Wealth preservation and protection are the primary goals of estate planning, and such goals will not subside with the death of the estate tax.

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