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The Return of the Estate Tax

The Return of the Estate Tax

SML Perspectives
(November 28, 2010)

Over the past several years the burden of the federal estate tax (along with other taxes) has been reduced. For the calendar year 2010 the estate tax has been repealed altogether. However, beginning January 1, 2011, the estate tax will once again apply to the estates of individuals who die after 2010 and, unless changed by legislation, the amount of property subject to the estate tax and the estate tax rates will increase substantially in comparison to recent years.

The Rules Through 2010

In 2001 the estate, gift, and generation-skipping transfer (“GST”) tax laws were changed substantially by the Economic Growth and Tax Relief Reconciliation Act of 2001 (commonly known as “EGTRRA”). In 2001 the amount of property which was exempt from the estate tax was $675,000. This exemption was increased to $1,000,000 in 2002, $1,500,000 in 2004, $2,000,000 in 2006, and $3,500,000 in 2009. The GST tax exemption increased in a similar manner. The maximum estate, gift, and GST tax rate in 2001 was 55 percent, with a 5 percent surtax on large estates and large cumulative gifts. This rate was gradually reduced to 45 percent by 2007. For 2010, EGTRRA provided that the estate and GST tax would be repealed in full; however, the gift tax remained with a 35 percent maximum rate and a $1,000,000 lifetime exemption. For 2010 EGTRRA also imposed a carryover basis regime for income tax purposes. This regime provided that an individual inheriting property from a decedent did not receive a new basis in the property equal to the property’s value at the time of the decedent’s death. Rather, the individual inheriting the property generally took the same basis in the property held by the decedent immediately prior to death, subject to certain adjustments made available to the individual.

The Existing Rules for 2011 and Thereafter

Effective January 1, 2011, the provisions of EGTRRA expire, and the law generally returns to those rules which were in effect prior to EGTRRA. Generally, effective January 1, 2011, the rules will be as follows:

The amount of property exempt from the estate tax will be only $1,000,000.

The gift tax exemption will be $1,000,000.

The top estate, gift, and GST tax rate will once again be 55 percent, with an additional 5 percent surtax for estates and cumulative gifts having a value in excess of $10,000,000 but not in excess of $17,184,000.

The exemption from the GST tax will be an inflation-adjusted amount of approximately $1,340,000.

The carryover basis rules will no longer apply, and once again an individual inheriting property generally will take a new basis equal to the property’s value at the time of the decedent’s death.

Planning for the Balance of 2010 and Thereafter

Planning in the face of these new requirements, as well as for any changes in the law (if any) which may occur between now and the end of calendar year 2010, presents quite a challenge.

First, for the year 2010, it certainly is possible that Congress may attempt to re-impose the estate and GST tax on a retroactive basis. The likelihood that Congress will do this appears to be diminishing as time passes. Further, if retroactive legislation is enacted, it is questionable whether the ability to do this on a retroactive basis is Constitutional.

Second, for 2011 and thereafter, and assuming that the law is not changed, working with these new rules could be extremely difficult. It is easy to say that the EGTRRA provisions “expire” or are “repealed” effective January 1, 2011, but determining what that means in a given situation may be extremely difficult.

EGTRRA was enacted in haste. The general expiration of the EGTRRA rules, effective January 1, 2011, was included not as a well thought out plan but solely because the legislative process required that EGTRRA not increase projected federal deficits after 2010. Although certain provisions of the Internal Revenue Code have expired in the past, we generally have not had this type of wholesale expiration in previous tax legislation to serve as a guide. The EGTRRA expiration provisions state that the EGTRRA estate, gift, and GST tax rules are not to apply to the estates of decedents dying, gifts made, or generation-skipping transfers, after 2010. However, the EGTRRA expiration provisions also state that after 2010 the tax laws will be applied and administered to years, estates, gifts and transfers “as if the provisions and amendments described [by EGTRRA] had never been enacted.”

Many provisions of the estate, gift, and GST tax laws have a cumulative effect. To say that the EGTRRA provisions no longer apply after 2010 can mean one thing. To say that the laws are to be administered as if EGTRRA had never been enacted can mean something completely different.       Applying the EGTRRA expiration provisions will be quite a challenge in some situations.

Current Legislative Proposals

In the face of this confusion, a number of proposals have been made to change the tax laws for 2011 and thereafter. Although there is no consensus whatsoever, and making an educated guess at this time relies less on the “educated” and more on the “guess,” there does appear to be some loose belief that the estate tax rules might be amended somewhat along the lines of legislation proposed by several Senators. This proposal would in part do the following:

  • Continue the $3,500,000 exemption from estate taxes as it existed in 2009.
  • Institute progressive estate tax rates as follows:

Size of Estate Estate Tax Rate
Estates over $3,500,000 but not over $10,000,000 45%
Estates over $10,000,000 but not over $50,000,000 50%
Estates over $50,000,000 55%

In addition to the rates described above, impose a 10 percent surtax on estates having a value over $500,000,000.

The Timeliness of a Review

As is obvious from all of this, planning over the last few years, and particularly during 2010, has been extremely difficult. It may be that order will be restored by Congress at the end of 2010 or early in 2011, but it is also equally possible that we may simply revert to the pre-EGTRRA rules described above, which would result in a significant potential increase in the estate, gift, and GST tax and the continuation of a certain amount of confusion. All of this requires very careful consideration. For those who have been waiting to see what develops before undertaking a comprehensive review of their estate plans, hopefully we should know within the next several months what the rules will be so that a meaningful review can be undertaken.

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William L. Dennis
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