Congress' Inaction Creates Need to Review Estate Plan

Many people were astonished that Congress failed to extend 2009's $3.5 million applicable exclusion from estate tax into 2010. As a result, the estate tax and the generation skipping transfer tax have now been repealed, as provided for under the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"). While many are rejoicing at the repeal of the estate and generation skipping transfer taxes, the party will be short-lived - as EGTRRA provides for the rebirth of both taxes in 2011 for estates in excess of $1 million. Meanwhile, the temporary repeal in 2010 has brought its own new problem - the "carryover" basis. All these changes make it mandatory that your clients have their estate plans reviewed, especially those clients with children from prior relationships or extensive holdings of appreciated assets.

The repeal of the estate tax will cause many estate plans with formula clauses to either: (1) require court interpretation as to what was intended by the decedent, (2) leave everything to the "Credit Shelter Trust," or "Bypass Trust," (3) leave everything to the surviving spouse, or (4) leave everything to the children of the deceased spouse, to the exclusion of the surviving spouse. If the result under the new law is acceptable, then no changes may be necessary. But, if the result achieved is not what the client intends, the estate plan will need to be amended to achieve the desired result.

The new "carryover" basis rules may cause beneficiaries to receive their inheritance at an income tax basis equal to the lower of the income tax basis of the decedent or the value of the assets at the decedent's death, rather than the "stepped-up" basis equal to the value of the assets at the decedent's death, as was previously the case. This could result in an administration nightmare, as executors and trustees scramble for documentation to establish the basis of assets acquired decades ago. The last time Congress attempted to establish a "carryover" tax regime, the law was repealed retroactively within six months of its enactment. Will there be a repeat of history this time around, or will Congress allow the law to stand as-is until the restoration of the estate tax in 2011? No one knows for sure. Both sides of the aisle in Congress have political reasons to leave the law unchanged as well as to "fix" the estate tax in 2010.

While assets generally get the basis outlined above, the decedent's estate may allocate up to $1.3 million of additional basis to assets going to anyone. In addition, the estate may allocate up to an additional $3 million in additional basis to certain assets passing to the surviving spouse. Of course, the estate cannot increase the basis of any asset to more than its value at the decedent's death. For clients with significant appreciated assets, the typical formula allocation clauses in current estate plans will not optimize the split of assets being allocated between the surviving spouse and the descendants of the deceased spouse in light of these opportunities for additional basis. Clients with significant appreciated assets will lose valuable income tax savings if they do not have their estate plans updated to take advantage of this change in the law.

With the elimination of the generation skipping transfer tax and the gift tax lowered to a 35 percent rate for transfers in excess of $1 million, now may be the time to act for clients with large estates and a desire to leave significant assets to grandchildren and great-grandchildren. However, the window of opportunity will be short, no matter what course of action Congress takes.

Now, some commentators think that Congress will not act in 2010 and will simply allow the estate tax to be reinstated at its lower exemption level in 2010. Others believe that Congress will reinstate the estate tax and do away with "carryover" basis, either retroactively or prospectively only, sometime in early 2010. Still other commentators believe that Congress will only act to eliminate "carryover" basis, but will leave the estate tax provisions of EGTRRA in place. Whatever Congress ends up doing, your clients should not delay in having their existing estate plans reviewed as soon as possible to avoid unwanted consequences in the event of their death this year.

BREAKING NEWS

On January 20, 2010, the Senate took the procedural steps for placing estate tax legislation (H.R. 4154, known as "the Permanent Estate Tax Relief for Families, Farmers and Small Businesses Bill of 2009," which passed the House of Representatives by a vote of 225 to 200 on December 3, 2009) directly on the Senate calendar, bypassing the Senate Finance Committee. If passed in its current form, the bill would provide for a permanent $3.5 million estate tax and generation skipping tax exemption amount, a $1 million lifetime gift tax exemption amount, a 45 percent estate and gift tax rate, and a "step-up" in basis at death. Is this a sign that Congress will act soon to "fix" the estate tax? Given the track record of the forecasters thus far, it is perilous to predict whether and how Congress will act.