Important Estate Tax Law Changes
There have been two surprising developments in estate tax law during 2009. Despite expectations, Congress has failed to stop next year’s one-year federal estate tax repeal. Equally surprising was Delaware’s enactment of a temporary estate tax.
Decedents who die during 2010; gifts made during 2010
It now appears virtually certain that federal estate and generation-skipping taxes will be repealed for the year 2010, despite all previous predictions to the contrary. Assuming Congress does not intervene, estates of people who die during calendar 2010 will owe no federal estate tax, no matter how large the estate.
Repeal of the estate tax will result in “carryover basis,” meaning that the cost basis of property inherited from someone who dies during 2010 will not be “stepped up” to the date of death value, although basis may be stepped down. The executor will have ability to “step up” the basis of some assets ($1,300,000 for non-spouse beneficiaries and $3,000,000 for certain gifts to spouses), which will help alleviate the burden. However, heirs of decedents who die during 2010 could incur income tax when they sell certain inherited assets. If the present $3,500,000 estate tax exemption were continued during 2010 it would have only affected 6,000 estates nationwide, but due to carryover basis, the one year repeal of the estate tax during 2010 is expected to affect more than 70,000 estates.
As noted above, Delaware enacted an estate tax for decedents dying between July 1, 2009 and June 30, 2013. Although the statute is ambiguous, Delaware Division of Revenue officials say the tax will only apply to estates over $3,500,000. Marital and charitable deductions will apply.
The federal gift tax law will continue in 2010, but with a 35% top rate instead of the current 45% top rate. Delaware continues to have no gift tax.
Decedents who die in 2011 and later
Assuming the law is not changed, the federal estate tax will reappear in 2011 with an exemption of $1,000,000 per person, and with unlimited marital and charitable deductions. Estate tax rates on the excess will begin at 41%, increasing up to 55% on the largest estates. There will no longer be “carryover basis,” as the “step up” in cost basis to date-of-death value will resume. Various other provisions affecting conservation easements, closely held businesses, and generation-skipping transfers, will change as well.
Effect on wills and trusts
If Congress fails to change the law, the one-year repeal will affect estate plans based on a tax-driven formula. An example of a tax-driven formula is a will that creates a trust for a spouse to be funded with “that amount necessary to reduce taxes to zero.” During the year of estate tax repeal, such a provision would mean no trust would be created. Simple plans with no tax-driven formulas, such as those for clients with smaller estates, are less likely to be affected.
Individuals who are particularly concerned about death during 2010 should attempt to locate and organize cost basis information. As mentioned above, the executor will have the ability to allocate $1,300,000 of unrealized gain to non-spouses, and $3,000,000 to marital gifts.
It may make sense to make taxable gifts – those over $13,000 per donee – during 2010, while the gift tax rate is temporarily reduced. The one-year repeal of the generation-skipping tax creates substantial uncertainty about creation of generation-skipping trusts during 2010, because when the tax is revived in 2011, such trusts may not be exempt. Outright gifts to grandchildren will not be subject to such uncertainty. Certain other types of transfers, such as grantor retained annuity trusts, merit special consideration. Gifts involving valuation discounts (such as gifts of LLC or partnership interests) would be useful in 2010, since such discounts will likely be curtailed in the future.
The new carryover basis rules for those dying in 2010 will make estate administration more complicated. Special emphasis should be placed on gathering solid information about the cost basis of every asset. As previously noted, the executor can allocate unrealized appreciation of $1,300,000 to estate assets, which is helpful to the heirs who receive those assets, but makes the executor’s job much more difficult. In addition, the executor can allocate $3,000,000 of unrealized appreciation to property passing to a surviving spouse. These rules do not apply to qualified retirement plans, such as IRAs.
As mentioned above, the new Delaware estate tax applies to estates over $3,500,000, with rates from 9.6% to 16% on the largest estates, although a limited deduction results in somewhat lower effective rates. In its current form, the Delaware estate tax will be in effect for four years, expiring on July 1, 2013. Estate tax returns are due 9 months after death. Interestingly, it appears that Delaware will continue to impose an estate tax in 2010, even though the federal estate tax is repealed for one year. The law applies to Delaware residents as well as non-residents who own real estate or tangible personal property in Delaware, with non-resident estates taxed on the fraction representing Delaware assets. Delaware estate planning lawyers are seeking repeal of this new estate tax.
In summary, although we continue to closely monitor the situation, we cannot know whether, how or when these political issues may be resolved.
IRS Circular 230 Disclosure:
Pursuant to Treasury Regulations, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used or relied upon by you or any other person, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any tax advice addressed herein.