Temporary Estate Tax Repeal In Effect – At Least For Now, And May Offer Planning Opportunities
On January 1, 2010, the federal estate and generation skipping-transfer (“GST”) taxes are scheduled to temporarily expire — each individual dying in 2010 would have an unlimited federal estate tax exemption. Ever since the 2010 “repeal” of the estate tax was first enacted, virtually all commentators have expected Congress to keep this repeal from ever happening by enacting a permanent estate and gift tax solution, or, at the very least, temporary legislation maintaining the status quo. But Congress has not done so, and it appears as though we will begin 2010 with repeal in effect. Some in Congress have made clear their intention to enact temporary or permanent legislation in early 2010 reinstating the tax, retroactive to January 1, 2010. But few, if any, ever expected us to arrive where we are today, so at this point, what will actually happen and when is extremely difficult to predict. This creates tremendous uncertainty from a planning perspective, but could also create tremendous opportunity.
By way of background, current federal estate tax law provides each individual dying in 2009 with a $3.5 million federal estate tax exemption and establishes a maximum federal estate tax rate of 45 percent. The GST tax exemption for 2009 is also $3.5 million. But the gift exemption is only $1 million, meaning that an individual may only make $1 million of tax-free gifts during his or her lifetime. The current gift tax rate on amounts in excess of the gift tax exemption is 45 percent.
Under current law for 2010, although the federal estate tax and GST tax would temporarily expire, the gift tax remains intact, still limiting an individual to $1 million of lifetime gifts, but with the gift tax rate dropping to 35 percent. Furthermore, the basis of property inherited in 2010 for calculating capital gains when the recipient eventually sells the property will be the same basis as in the hands of the decedent (a carryover basis). (Some basis step up would still occur, with the law allowing a decedent’s estate to allocate a basis step up to $1.3 million of assets passing to anyone and an additional up to $3 million of assets passing to a spouse.) In these regards, the 2010 “repeal” year is less taxpayer-friendly than advertised.
But the 2010 rules may have significant loop holes that have not been closed, likely because the rules were never intended to actually apply. For instance, even though the gift tax remains generally intact, the rules as drafted seem to permit tax free gifts to certain types of trusts. It is possible that such gifts could remove the given property from a client’s estate, and even exempt such property from GST taxation, without generating any gift tax – a true “home run” for the client’s family.
We would expect Congress (or the Treasury through regulations) to eventually close this and other possible loop holes. But when Congress will take up the issue is far less certain, as is the effective date of any possible 2010 legislation. There is always the chance that Congress could move to close this and other loop holes retroactively, or attempt to eliminate repeal altogether retroactively. But Constitutional issues brought by retroactive legislation could cause Congress to instead leave open the early 2010 planning window, with any proposed legislation effective only as of the date of introduction. And Treasury regulations are often prospective only. Moreover, Congress could choose to take no action at all in 2010 and instead allow the current legislation to take its course — after 2010, the maximum federal estate tax and GST tax exemptions are scheduled to return to $1 million (equal to the gift tax exemption), and the maximum federal estate, GST and gift tax rates will return to 55 percent, with full basis step up for inherited property will then be reinstated. The bottom line is that until something changes, these are the laws applicable for 2010.
As for where this leaves us now, we believe that the current uncertainty creates potential planning opportunities. The planning opportunities are not appropriate for everyone, as the planning comes with associated risks and we cannot predict its chances of success. But we would be pleased to discuss the possibilities with you, including ways of mitigating possible risks, and determine whether any planning opportunities are suitable for your situation.
If you would like to discuss the possibility of early 2010 planning transactions, please do not hesitate to contact us. What will happen to the current 2010 laws and when is anybody’s guess. But anything seems possible at this point.