Estate and GST taxes—Where We Are and Where We’re Headed if Congress Doesn’t Act
Estate and generation-skipping transfer (GST) taxes have been repealed for 2010 but are scheduled to return in 2011. Next year’s rules, however, won’t be those that applied during 2009 when these taxes were last in effect. Rather, unless Congress acts, rules from 2001 will apply for next year. This Practice Alert explains what repeal means, what old rules are scheduled to return in 2011, and relevant concerns and planning considerations both for this year and next year.
This Year’s Transfer Tax Picture
The Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) repealed the estate tax for decedents dying after Dec. 31, 2009 and before Jan. 1, 2011. However, it did not repeal the gift tax for gifts made during 2010, although it did reduce the top rate from 45% to 35% for gifts made in 2010. A prominent estate planner posits that the reduction of the top gift tax rate makes this year an ideal time for gifting by affluent clients.
Because the estate tax is repealed for decedents dying in 2010, no estate tax is due and there is no need to file a Form 706, United States Estate (and Generation-Skipping Transfer) Tax Return.
EGTRRA also changed the basis rules for individuals acquiring property from a decedent dying in 2010. Generally, for the estates of decedents dying after Dec. 31, 2009 and before Jan. 1, 2011, the basis of assets acquired from a decedent is the lesser of the decedent’s adjusted basis (carryover basis) or the fair market value of the property on the date of the decedent’s death. However, there are two exceptions to this general rule:
•The executor can allocate up to $1.3 million, increased by unused losses and loss carryovers ($60,000 in the case of a decedent nonresident not a U.S. citizen, but with no loss or loss carryover increase), to increase the basis of assets; and
•The executor can also allocate an additional amount, up to $3 million, to increase the basis of assets passing to a surviving spouse, either outright or in a Qualified Terminable Interest Property (“QTIP”) trust.
The allocations of the general basis increase and the spousal property basis increase must be made by the executor on the tax return required by Code Sec. 6018.
EGTTRA also repealed the GST tax on direct skips, taxable terminations, or taxable distributions occurring after Dec. 31, 2009 and before Jan. 1, 2011.
Next Year’s Transfer Tax Picture if Congress Doesn’t Act
Under the sunset rule, the EGTRRA estate tax repeal and gift tax changes will be gone, effective Jan. 1, 2011. Therefore, absent Congressional action, the estate tax will apply to decedents dying after Dec. 31, 2010, and there will be a $1 million exemption amount for estates of decedents dying, and gifts made, in 2011. For generation-skipping transfers in 2011, the exemption amount will be $1 million with an inflation adjustment. For decedents dying, and gifts made, in 2011, the maximum rate for estate, gift, and GST tax will be 55%, with a surtax for estate and gift transfers between $10 million and $17,184,000.
EGTRRA made other changes to the transfer tax rules that also are scheduled to sunset after 2010. For example, it repealed the State death tax credit and replaced it with a deduction. Under the sunset rules, the deduction would end and the credit would return in 2011.
EGTRRA also repealed the qualified family-owned business deduction, which would return in 2011. It also made modifications to the rules regarding (1) qualified conservation easements, (2) installment payment of estate taxes, and (3) various technical aspects of the GST tax. These modifications would terminate under the sunset rule.
Planning Concerns and Considerations
The current muddled state of affairs raises a number of planning concerns and considerations including the following:
•Possible law changes. It is unclear whether Congress will alter the estate tax repeal rules for 2010. Under repeal, heirs of many smaller estates could come out worse than if the estate tax had remained in force. That’s because, while these individuals won’t face transfer tax costs, they could face income tax costs. Thus, Congress could alter the rules for 2010 decedents to allow a choice between repeal (not paying an estate tax, but being subject to the modified carryover basis rules) and the rules that applied for 2009 (a $3.5 million estate tax applicable exclusion, 45% tax rate, and the step-up in basis rules for estate assets). It also is uncertain as to whether lawmakers will allow the sunset to go into effect next year. Many commentators believe that, at the very least, for 2011 and later years, Congress will restore the rules that applied for 2009.
•Basis issues. The modified carryover basis rules pose some thorny issues for estates of decedents dying in 2010. For example, it is not clear whether assets sold before a basis allocation is made can receive a basis increase. In view of this factor, the uncertainty of possible law changes, and the lack of guidance from IRS, where practicable, it may be advisable to postpone sales of estate assets until the picture become clearer. But no time should be wasted in rounding up records that may be needed to establish carryover basis. Also, it should be borne in mind that appraisals may be needed for assets to which basis increases will be allocated. Beneficiaries should be apprised as to how basis allocation may affect their income tax planning.
•Formula clauses. Formula clauses that work well when the estate tax is in force may produce unintended tax consequences when there is no estate tax. Specifically, there are issues as to how formula clauses in wills and trusts using estate or GST tax terms (e.g., “the applicable exclusion amount,” or “the marital deduction”) will be construed for a decedent dying in 2010.
•Dying clients. The will of a client who is expected to die before 2011 should be reviewed and modified if necessary to prevent a formula clause from disposing of assets in a manner not intended by the client. A gift to the dying client from his or her spouse should be considered if the dying client lacks sufficient assets to take advantage of the basis increase under the modified carryover basis regime. If it looks like a dying client will survive until 2011, it may make sense to make taxable gifts very late in 2010 to take advantage of the 35% gift tax rate.
•Clients whose death is not imminent but have short life expectancies. Because the estate tax returns in 2011, and the maximum estate and gift tax rate will be 55% next year, it may make sense to have a client who is expected to die in 2011 make gifts this year when the top gift tax rate is 35%. However, in implementing such a strategy, practitioners should bear in mind that gifted assets get a carryover basis whereas post-2010 transfers at death will get a step-up in basis.
•Non-exempt GST trusts. Consider 2010 distributions from non-exempt GST trusts as they will escape GST taxes.
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