ESTATE TAX UPDATE

With the departure of 2009, we find ourselves in a period of uncertainty for estate tax planning. During 2009, the federal estate tax and generation-skipping transfer tax exemptions were at a high of $3,500,000. The maximum rate of tax was at a low of 45%. As 2010 begins, no federal estate tax and no generation-skipping transfer tax exist. In 2011, both taxes are scheduled to reappear with an exemption of only $1,000,000 and a maximum rate of 55%.

Expectations were high that Congress would extend the 2009 provisions through 2010 until it had an opportunity to review these laws thoroughly. Unfortunately, Congress failed to act on this issue in 2009.

Despite this uncertainty about federal estate and generation-skipping transfer taxes, the gift tax remains in place. The rate of tax has, however, decreased from 45% to 35% for 2010. The lifetime exemption remains at $1,000,000 and the exemption for annual gifts continues to be $13,000. Further, the exemption for gifts to non-U.S. spouses also remains unchanged at $133,000.

The Maine estate tax provisions remain unchanged for 2010. The exemption is $1,000,000 and the Maine marital trust deferral provisions remain applicable.

A potential cost to individuals who die in 2010 is one of a capital gains tax. Through 2009, an unlimited amount of assets could receive a step-up in cost basis to fair market value on the date of death. As a consequence, most inherited property could be sold immediately after death without incurring significant (if any) capital gain taxes. (The major exceptions to this step-up in basis benefit are retirement plans, annuities and other income tax-deferred investments.)

In 2010, a modified carryover basis applies; the cost basis of inherited assets will be the lesser of fair market value as of the decedent's date of death and the cost basis in the hands of the decedent. However, the law does provide for a step-up in basis for appreciated assets totaling no more than $1,300,000 in appreciation (but not in excess of the fair market value of the selected property as of the decedent's death). An additional $3,000,000 step-up in basis is available for property passing to a surviving spouse (whether outright or in a marital trust).

What is expected?
The 2009 estate tax discussions in Washington concluded with a plan to resume the estate tax debate in 2010. Many have suggested extending the 2009 provisions through 2010 with a retroactive application to January 1, 2010. Others have expressed concern that a retroactive application may be unconstitutional. For persons who die in 2010 before new legislation is passed, the imposition of estate taxes remains unclear.

What should you do?
Married couples whose estate planning documents incorporate disclaimer plans may not need to redo their entire plans. The control maintained by the surviving spouse should provide flexibility to avoid any unintended consequences of both the federal estate tax hiatus and carryover cost basis. A review of each person's plan is the wisest course as some plans may require adjustments.

For those couples who have formula-based estate plans that are tied to the federal estate tax exemption, changes are very probably warranted. The formula may now divert assets from the surviving spouse at a level that was not contemplated when the plan was written. Formulas linked to the federal charitable deduction may fail to produce the desired result among beneficiaries. Immediate review of these formula-based plans is critical in situations of bad health.

Keeping track of cost basis will now be more important. Both the value of property held separately by spouses and the unrealized gain on those assets require attention.

Personal Representatives of estates of persons dying in 2010 will need to consider the ramifications to beneficiaries as they allocate cost basis step-up among assets. They also will need to ascertain the basis of a decedent's assets before selling some of those assets to raise money for debts and expenses and to fund distributions to beneficiaries because significant capital gains taxes may be incurred.

For individuals who have used their lifetime exemption from estate tax, making taxable gifts in 2010 may be worth the risk. The 35% gift tax rate in 2010 will likely be less than the estate tax that returns in 2011. In addition, the 45% gift tax rate is expected to return when Congress acts.