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Repeal of the "Death Tax"?
Michelle M. Arruda

To the surprise of just about everyone in the tax and estate planning community, we reached the end of 2009 without any federal legislation to avoid the whiplash from repeal of the federal estate tax for only one year and the potential whiplash from the retro-active reinstatement of the estate tax during 2010.

Here’s a quick reminder of our current federal “death tax” regime.

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”). Under EGTRRA:

The estate and generation-skipping transfer (“GST”) tax exemptions have been increasing over the years, with each reaching $3.5 million as of January 1, 2009.
The gift tax exemption reached $1 million on January 1, 2002, and has remained there ever since.
As of January 1, 2010, the estate and GST taxes – but not the gift tax – have been repealed.
As of January 1, 2010, the gift tax exemption remains at $1 million and the top rate has been reduced to 35%.
As of January 1, 2010, an inherited asset no longer receives a “stepped-up” cost basis equal to its date of death value. The basis “step-up” rule under prior law eliminated a capital gain tax on an inherited asset’s pre-death appreciation. As of January 1, 2010, the basis “step-up” rule has been replaced with a modified “carryover basis” rule, under which an inherited asset retains its pre-death cost basis or acquires a new basis equal to the asset’s fair market value on date of death, whichever is lower. In addition, the executor is permitted to allocate up to $1.3 million of additional basis to the decedent’s assets, plus up to another $3 million in additional basis for assets passing to or in trust for a surviving spouse. Thus, in essence, the estate tax has been replaced with a capital gain tax, and the estate tax exemption has been replaced with a capital gain tax “exemption.”

But don’t forget that EGTRRA “sunsets” on January 1, 2011. That means that after only one year of repeal, the estate and GST taxes come back into existence with exemptions of only $1 million (although the GST exemption is indexed for inflation) and top rates of 55%; the top gift tax rate increases to 55%; and inherited assets once again will receive a stepped-up basis.

And remember, also, that if you are a resident of, or own real estate in Massachusetts, Maine, or any other state that has its own estate tax system, you still are subject to that state’s estate tax. Repeal of the federal estate tax under EGTRRA did not affect those states’ estate tax rules.

What’s Next?

Congress may pass legislation reinstating the estate and GST taxes as of January 1, 2010. Congress may pass legislation reinstating the estate and GST taxes effective sometime during 2010. Congress may do nothing and simply let EGTRRA sunset, leaving us with one year of repeal and then sending us back to pre-2001 law. Each of these possibilities carries its own political ramifications. And whether retro-active reinstatement is constitutional remains to be seen. Retro-active tax changes have been upheld in the past.

What Should You Do and What Shouldn’t You Do?

Since we do not know if, when, or how Congress will act, we recommend that you review your current estate plan to be sure that, regardless, your wishes are carried out. If you die while the estate tax no longer is in effect, the provisions describing the distribution of your estate may now be ambiguous and as a result, your estate may pass in a manner you did not intend. For example, married couples often have an estate plan that contains a formula for distributing their assets based on the federal estate tax exemption. In addition, you will want to be sure that the new modified basis rules, if they apply, will be applied to the greatest advantage of your heirs.

If you have any doubts or questions, please contact us to schedule a review of your plan. We urge the following persons in particular to give us a call:

You are married and your estate plan contains a formula or other type of provision that references the federal estate tax. This probably applies to married couples where each spouse has his or her own revocable trust.
Your plan contains a charitable gift that references the federal estate tax.
Your plan contains one or more gifts to grandchildren or trusts for grandchildren that reference the federal GST tax.

The changes in the law also may present planning opportunities for some of you. We are happy to discuss those opportunities with you.

If the modified basis rules will be effective for any part of 2010 and into the future, you should be even more conscientious with your record-keeping concerning asset purchases and sales.

Finally, we certainly advise you NOT to assume that “death taxes” are dead!

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