March 10, 2010
Re: Estate Tax Changes
What a mess Congress has created! We are now in a year when there is no federal estate tax — but hold the cheers. Congress has
substituted another method of taxation that will collect more taxes from many of our clients and families than the estate tax. Additionally, these changes will, for some, greatly alter planned-for and anticipated distributions among family members and heirs.
A brief review of the law will help explain why this is so significant. The 2001 tax act gradually reduced the maximum rate of the
federal estate tax from 55% to 45%. It also gradually increased the amount of property that you could pass free of federal estate tax from $675,000 per person in 2001 to $3.5 million per person in 2009. That means that with basic estate planning, a married couple could pass up to $7 million free of federal estate tax if both spouses died in 2009.
Then, in 2010 only, the 2001 tax act repeals the estate tax. But like a horror film character who just won’t die, under the existing law the estate tax returns again on January 1, 2011 — only at a much lower $1 million exemption and a higher maximum 55% tax rate! This strange “now it’s gone, no it isn’t” effect is the result of a rule in Congress that attempts to limit budget deficits.
Paying for Estate Tax Repeal
To pay for this one-year vacation from the estate tax, Congress replaced the estate tax with an increased income tax. Before 2010, any assets (other than retirement accounts and U.S. Savings Bonds) that pass to heirs when someone dies would be valued at fair market value at the date of death. After death, when a surviving spouse or heirs sold any assets (like securities or a home), they would not have to pay income tax on any of the growth in value of those assets that occurred during the decedent’s life. This is called a “step-up in basis.” For many heirs this means big, big income tax savings.
But in 2010 property that passes at death does not automatically receive this step-up in basis. Instead, each individual has a limited
amount of property that can be “stepped-up” in value at the time of death. Property that does not receive this stepped-up value will be subject to tax on all increases in value from the date the decedent first acquired the property. This means your heirs could be exposed to tens of thousands of dollars of income tax liability!
Planning in Chaos
Congress’s failure to adopt estate tax legislation in 2009, plus the possibility that changes will not be adopted during 2010, radically changes the estate planning considerations of many of our clients. For example, in 2010 about 6,000 decedents will benefit from the elimination of estate taxes, but over 70,000 heirs will pay higher income taxes because of the change in the income tax basis rules.
How You Are Affected?
This law can affect you in several ways. First, we need to make sure your property will be divided according to your desires, not as
dictated by Congress. For more than fifty years it has been common to use a written mathematical formula to divide the assets of a
married couple when the first spouse dies to maximize estate tax savings. Similar formulas have been used to provide funds for charitable causes and to benefit family and friends. Now, in 2010 when there is no estate tax, these formulas may not work.
What Should You Do?
We encourage you to meet with us as soon as possible to review your estate plan and make any changes that are necessary under this law. Even though you are likely to live through 2010, you still need to prepare for the unexpected. This is a time that demands a new approach to your planning with new thinking and building in flexibility to see that your wishes are fulfilled no matter what Congress throws at us this year or next. We have solutions that will meet you planning objectives with the least amount of tax impact.
Please feel free to call our office to set an appointment so we can discuss how the changes in the tax law apply to your personal situation.
Very truly yours,
Jan Copley and Christopher B. Johnson
JC/lp
