Articles

Federal Estate Tax-The Continuing Saga

By Earl H. Cohen, Attorney at Law

Mansfield Tanick & Cohen, P.A.

Just when we expected congress to extend the current federal estate tax system by passing the House's version of an extender bill (the Permanent Estate Tax Relief for Families, Farmers and Small Businesses Bill of 2009, H.R. 4154), the senate ran out of time to deal with the bill, having spent nights and weekends to pass its version of the health insurance legislation. The House Bill retains the federal estate tax at its current 2009 levels on a permanent basis beginning in 2010. There is little doubt that the health insurance legislation was a major priority this year, however, where does the failure to extend the system leave us, our estate plans and the U.S. Treasury?

Background. As a matter of background, the current legislation passed by congress in 2001 provides for an estate tax exemption for each estate that rose to $3.5 million in 2009 ($7 million for couples) and repeal of the estate tax on January 1, 2010. On January 1, 2011 the estate tax returns with a $1 million exemption ($2 million for couples). The repeal doesn't eliminate the gift tax. The gift tax remains in place with a $1 million lifetime exemption. To the extent used, the gift tax exemption continues to reduce the estate tax exemption at death. The 2001 legislation also provides for a conversion of the current "step up in basis" rules to a "modified carryover basis" system. "Step up in basis" rules result in a taxpayer's tax basis on an inherited asset rising to the market value of the asset on the date of the decedent's death. "Carryover basis" rules, with some modification, result in basis, in the hands of the persons inheriting property, equal to the decedent's basis in the property. The "carryover basis" rules remain in place even after January 1, 2011. This means we end up with a federal estate tax (with a smaller exemption and thus affecting more Americans) and a capital gains tax on the inherited property with unrealized gains in excess of $1.3 million when it is sold.

How does this affect estates of those dying in 2009 and existing estate plans? Before getting too excited about the temporary elimination of the "death tax," keep in mind that Congress has nine months to effect a "fix" either by passing a version of the House's bill extending the current estate tax system or going for more comprehensive reform. Why nine months? September 30, 2010 would be the due date for a federal estate tax return for someone dying on January 1, 2010. The expectation is that such legislation would be retroactive to January 1, 2010. Whether a retroactive bill would be constitutional remains a question. We should expect that if a law is passed effectively reinstating the estate tax (eliminating the repeal of the estate tax), estates of those dying during 2009 will likely have to comply with the law and that means filing the necessary returns and paying the tax while the battle over constitutionality is waged in the courts. As to existing plans, those clients with estates in excess of $1 million should be conducting a comprehensive review of the tax provisions of their plans with their estate planning advisors. Those tax provisions should be reviewed to determine the tax result for, at least, the two most likely scenarios: (1) where the current estate tax regime is extended; or (2) where the estate tax is actually repealed and the federal estate tax exemption drops to $1 million on January 1, 2011. This doesn't necessarily mean that there is an immediate need for complete amendment of each plan, but the review will help identify issues that will have to be dealt with once Congress acts (or fails to act) on this issue. Estate plans that have not been updated in the last nine years may not deal clearly with the circumstance of estate tax repeal. Other estates may have been "over planned" with administrative provisions that are now unnecessary under one or both scenarios. Other plans may not have adequately planned for the difference in the federal and state estate tax exemptions. Minnesota and many other states disengaged from the federal system establishing their own estate tax system with a different exemption. Failing to provide flexibility for the differences between the exemptions may, by itself, result in an overpayment of estate tax.

Where does estate tax repeal leave the treasury? Historically, the estate tax has provided between one and three percent of the total tax revenue raised by Treasury. In this period of massive federal deficits, it's unlikely that Congress is going to allow repeal to just happen, especially when the estate tax affects the wealthiest of the population. More importantly for this Congress and the administration, if the estate tax is allowed to come back in 2011 with a $1 million exemption, small business owners and farmers are likely to be the largest group of taxpayers affected.

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 estate and how you can obtain review of the tax provisions of your existing estate plan.