Dying isn’t getting any easier. The federal estate tax rules changed radically in 2010 and could change radically again in 2011 unless Congress passes new laws in the lame duck session after the mid-term elections.
In 2001, Congress passed legislation which provided for lower tax rates and significant phased-in increases in the federal estate, gift, and generation skipping tax (GST) exemptions. As a result, in 2009, the estate exemption increased to $3.5 million per decedent, with a flat 45% estate tax on any excess.
Then, in 2010, the federal estate tax was repealed for one year. The step up in basis rules (which gave a “fresh-start” fair market basis for most assets of a decedent) was replaced with an adjusted carry-over basis. These new basis rules permit a step up in basis of up to $1.3 million, plus an additional $3.0 million for certain spousal transfers at death.
On January 1, 2011, the estate tax reverts to the 2001 laws, with an exemption of only $1.0 million and a tax rate up to 60%.
Every estate planner I knew expected Congress to carry the 2009 estate tax rules across 2010. In December, however, the House unexpectedly failed to act on a one-year extension and instead sent the Senate a bill to make the 2009 rules permanent. Because the Senate was focused on health care and there was broad disagreement in the Senate on what to do with estate taxes, Congress enacted no changes to the 2010 rules. So, as of January 1, 2010, there is no federal estate tax.
It is very possible that Congress may do nothing in 2010 and let the estate tax revert to the 2001 levels. It is also possible that after the November elections Congress will pass legislation retroactively extending the 2009 exemption and tax rates to 2010. While doing so would be almost unimaginable and raise the current chaos to levels never seen before, I would not rule out such a move by the current Congress. There is broad disagreement on whether a retroactive tax bill is constitutional. If a retroactive law is adopted, it will be challenged as unconstitutional and it could take years for the Supreme Court to rule on the issue.
The more desirable step would be for Congress to extend the 2009 exemption for one year and let the new Congress hash out what to do going forward.
Unless new legislation is passed after the November election, then on January 1, 2011, a number of automatic changes occur to the federal tax code. The estate tax exemption drops to $1.0 million and estate taxes increase to 55% above $3.0 million and 60% above $10 million. This means the heirs of a person with an estate of $3.5 million who died in 2009 would have paid nothing. If that person should die in 2011, the tax bill would be around $1 million. The only good news is that the fair market value step up in basis is also reinstated.
Congress’s failure to adopt estate tax legislation in 2009, plus the possibility that changes will not be adopted during 2010, drastically affects estate planning for many people. Some possibilities might include reconsidering whether you need life insurance to help cover estate taxes, giving more to children or charities now instead of through your will, or taking as much earned and capital gains income as possible in 2010.
The challenge is to plan for estate and income tax laws that may or may not be enacted. This uncertainty makes it more important than ever to work closely with a knowledgeable accountant, financial planner, and estate attorney.
