Articles

Your Estate Plan

By Earl H. Cohen

The Federal Estate Tax and What to Expect

Several months ago I described how Congress had failed to deal with the one year repeal of the Federal Estate Tax mandated by the 2001 tax reduction legislation. The one year repeal took effect on January 1, 2010. I noted that the House passed a version of an extender bill (the Permanent Estate Tax Relief for Families, Farmers and Small Businesses Bill of 2009, H.R. 4154), but the Senate ran out of time to deal with its bill, having spent nights and weekends to pass its version of the health insurance legislation, which, as of this date hasn't passed. The House bill retained the Federal Estate Tax at its 2009 levels on a permanent basis beginning January 1, 2010. Without further legislation the Federal Estate Tax comes back on January 1, 2011 with a $1,000,000 exemption (as compared to a $3,500,000 exemption for 2009). I pointed out what we thought were the two most likely scenarios: (1) Congress extends the estate tax regime that was effective in 2009, retroactive to January 1, 2010; or (2) Congress does nothing and the estate tax is left repealed for 2010 and the Federal Estate Tax comes back with a $1 million exemption on January 1, 2011.

Now that we are past Labor Day, and the midterm elections will be held in 60 days, it now seems unlikely that Congress will take any action to reinstate the estate tax for 2010. This also means that on January 1, 2011 our second scenario outlined above likely becomes law with a $1 million exemption and a 55% estate tax rate. And, as a reminder, the "step-up in basis" rule for property inherited from a decedent was changed to a "modified carry-over basis" rule on January 1, 2010.

The question now is what to do, if anything, before the end of 2010.

1. All existing estate plans must be reviewed before year end. Almost all estate plans have been driven by formulas and concepts designed to minimize Federal Estate Tax. In 2010 there is no estate tax and thus these formulas, in some cases, may actually maximize state estate tax. In other cases the formula may result in underfunding the share for a surviving husband or wife, frustrating the family's plan to care first for the surviving spouse. In many cases, especially those plans that have not been reviewed for nine or more years, the plan does not likely address the differences between the federal and state estate taxes that arose after Minnesota, and other states, decoupled from the Federal Estate Tax system. In the case of Minnesota's estate tax there is a $1,000,000 tax exemption and deductions that are based upon the federal system. An interesting problem will arise in a few months since the Minnesota Estate Tax Return requires calculations derived from the Federal return and so far, there will be no Federal Estate Tax form for 2009, since there is no tax. The Minnesota Department of Revenue has only recently begun to address this issue, since the first returns for deaths occurring on or after January 1, 2010, are not due until October 1, 2010. But that is less than 30 days from now. All plans need to address the modified carry-over basis rules that took effect on January 1st of this year. Without proper planning, families inheriting property could face substantial unnecessary capital gains tax even on relatively modest estates. Plans that have not been updated in the last five to nine years may no longer fit the family's needs. Recently developed planning ideas and concepts could easily be added to the plan to ease and speed estate administration and distribution of assets to beneficiaries. If the Federal Estate Tax returns on January 1, 2011 with a $1 million exemption, as the law currently provides, the tax will actually affect significantly more Americans than ever before and there will be many estates that will be unprepared for the tax and the cash necessary to pay it.
2. Other existing documents and agreements that related to the Federal Estate Tax system must be reviewed and revised by year-end. There are a myriad of documents and agreements that are out there whose terms are dependent on or related to the federal estate tax system. Prenuptial agreements are a good example. Many "prenups" contain provisions that are tied to Federal Estate Tax marital deduction concepts including the use of Qualified Terminable Interest Property trusts (QTIPs). QTIP trusts have often been used in prenups to assure the availability of a marital deduction for estate tax purposes in the event of the death of one of the spouses while assuring the parties that the assets in the trust will pass to particular beneficiaries after the second spouse dies in accordance with the prenup. Buy-sell agreements between owners of a business are another example of agreements that are affected by both the temporary repeal of the Federal Estate Tax and its return in 2011. Buy-sell agreements that deal with transactions between owners upon death and are or may be funded with life insurance need to be carefully reviewed to determine if estate and capital gains tax reduction techniques should be incorporated.
3. Individuals with estates that will be taxable in 2011 need to consider gifts to children and grandchildren yet this year. The temporary repeal presents some interesting planning opportunities. For those families with sizable estates, planning opportunities exist, including avoiding the generation skipping transfer tax, which also returns in 2011, through the use of irrevocable life insurance trusts for grandchildren as well as direct gifts and other gifts in trust.

The natural question is what should be done with existing estate plans to deal with these unusual problems. Once current estate plans, prenuptial agreements, buy-sell agreements and other business and financial planning arrangements are reviewed there are changes that can be put in place to provide the flexibility necessary given the current status of the Federal Estate Tax.

Please feel free to contact either Earl H. Cohen or Jeffrey C. O'Brien of the Estate Planning Group of Mansfield Tanick & Cohen, with questions on how the current estate tax issues affect your plan and how you can obtain review of your existing estate plan and other documents.