Estate Plans Imperiled

January 2010Alerts Tax & Estates Department Alert

In our most recent tax alert, we alerted you to the possibility that for decedents dying in 2010, there would be no federal estate tax and that the tax would return in 2011 with a lower exemption of $1 million and a higher tax rate of 55%. Despite the opinion of nearly all of the tax experts that there would be a revised tax law passed before the end of 2009, Congressional deadlock has resulted in the unimaginable, and the federal estate tax actually expired as of January 1, 2010. The result: clients who have implemented traditional estate plans that have incorporated Credit Trusts and Credit Bequests (tied into the federal credit equivalent, which was $3.5 million in 2009) are at the very least in a state of uncertainty for 2010 and at the very worst may have their planning objectives imperiled.

Where We Are

  • As of January 1, 2010, the federal estate tax and generation-skipping tax are repealed for one year.
  • There is still a federal gift tax, with a 35% tax rate. Annual tax-free gifts are limited to $13,000 per donee, and there is still a $1 million lifetime gift tax exemption.
  • The step up in basis provision for computing capital gains on inherited assets is also gone. In its place is a convoluted carryover basis system requiring the executor to make limited allocations of a partial step up in basis.
  • Lack of harmony in Congress makes it difficult to predict what changes 2010 will bring. However, there appears to be a consensus in Congress to restore the estate tax and generation-skipping tax, keep or increase the $3.5 million exemption and perhaps add a few more tweaks. Whether any changes in 2010 will be retroactive to January 1, 2010, or whether such retroactivity is even constitutional, is up for debate.

Who Is Affected?

  • A great many clients have set up wills that contain Credit Bequests or Credit Trusts that tie into the Applicable Credit Amount (or exemption as it is more familiarly known). The idea was to automatically adjust the amount going into the Credit Bequest as the credit changed from year to year. Now that there is no such thing as an Applicable Credit Amount, the impact of this type of bequest is to frustrate the testator’s intentions. Depending on how the bequest is worded, one possible result is that the entire estate goes into the Credit Bequest. Another interpretation would be that nothing would pass via the Credit Bequest, thus affecting the interests of whomever has been named as the beneficiary of the Credit Bequest. For example, if a client has left the Credit Bequest to children of a former marriage or even the children of his/her current marriage, the surviving spouse may be completely bypassed.
  • Clients may also have incorporated charitable trusts as part of their plan. Such trusts are specifically designed to minimize the impact of estate taxes. However, if there is no tax, do such trusts still “work?”
  • Many states, including NewYork, retain their own estate tax system. With the disappearance of the federal estate tax, the impact will be higher state estate taxes because state estate taxes will no longer be a deduction against federal estate taxes. Further, if the language of the will is interpreted to leave an unlimited amount to the Credit Bequest, the state will be able to impose its estate tax on the portion of the estate in excess of the $1 million exemption.

What Should You Do?

  • The impact of this uncertainty will be felt by nearly all of our clients, but particularly by clients who are gravely ill or who otherwise have a high mortality risk. Those in such circumstances should consult their counsel as soon as possible. In the meantime, we can suggest some temporary solutions: (1)Wait for Congressional action to correct the issues; (2) Execute codicils that define the Applicable Credit Amount as the amount that was in effect in 2009; and (3) Put off the day of reckoning by utilizing disclaimer trusts that enable the surviving spouse (within nine months after the deceased spouse’s death) to disclaim that amount that will maximize estate tax savings, while accomplishing the family’s planning objectives. However, we strongly caution that one size does not fit all. No alternative should be implemented without a careful analysis of each client’s needs and circumstances.
  • This letter cannot address all of the complicated issues caused by the repeal, and it is not intended as a complete review of the changes in the tax law. While we will keep everyone apprised of developments as they occur, we strongly encourage you to consult one of us to address the effect of these changes on your individual estate planning and to avoid potential unintended consequences under your current estate planning documents. (A reminder: please provide us with your current e-mail address.)

For more information, contact any member of our Tax & Estates Department.