2010 - The Year With No Federal Estate Taxes - Maybe
2010 is the year where there will be no federal estate taxes due to a law that was passed in 2001. The heirs of wealthy individuals who die this year are set to enjoy a huge windfall.
Several congressmen have vowed to reinstate estate taxes during the year. Indeed, the Senate Finance Committee Chairman, Max Baucus, has vowed that Congress will reinstate federal estate taxes retroactive to January 1, 2010.
The one year repeal of federal estate taxes and the threat of a retroactive repeal of the repeal requires planning for three separate tax systems that have very significant differences. System #1 is the law that currently exists for 2010. Even though you do not have to “worry” about federal estate taxes, planning for someone’s death in 2010 is challenging for several reasons.
First, Tennessee still has an inheritance tax with an exemption of only $1 million. Second, there are numerous Wills containing formulas that will not work if the testator dies in 2010. Third, most outright bequests should be converted to trust bequests in order to avoid estate or generation-skipping tax upon the subsequent death of the beneficiary.
Finally, System #1 eliminates the automatic step-up in basis for inherited assets. Heirs will need to obtain records that establish the decedent’s historical cost basis in his or her assets. Furthermore, if there was substantial appreciation, the heirs will incur capital gains tax when they later sell the assets. Each decedent has $1.3 million worth of basis increase that can be allocated by the executor. There is an additional $3 million worth of basis increase that can be allocated to assets passing to a surviving spouse. These “basis exemptions” will solve problems for most families, but will have numerous complications in their application.
System #2 is the law that will apply beginning in 2011, when the federal estate tax will reappear with a $1 million exemption and a top marginal rate of 60%. Planning for System #2 is very familiar because this system was in place prior to the changes made in 2001. A lot of families have assumed that the federal estate tax exemption was always going to be significantly higher than $1 million. They have failed to take planning steps that seemed to be unnecessary.
System #3 is what Congress might put into place later this year. My best guess is that System #3, if enacted, would be similar to the system that was in place for 2009. The House passed such a bill in December of 2009. The Senate elected not to pass this bill, but could change its mind. If there is a System #3, it is possible that it could make changes that were not part of the bill passed by the House in December of 2009. For example, discounts for Family Limited Partnerships could be eliminated.
Many people will assume that System #1 will not be relevant for them, because they will not die this year and/or the law will be changed before they die. If the law is not changed retroactively, it is inevitable that the families of some wealthy individuals who die this year will be disappointed despite the absence of federal estate tax.
There is widespread sentiment that System #2 will not arrive. I now believe that System #2 might arrive in 2011 because I have no confidence that the Senate will be able to get the 60 votes necessary to enact System #3.
You need to be prepared for all 3 systems. Fortunately, there are practical steps that can be taken to minimize taxes under all 3 systems.
