Starting January 1, 2010 we have to be prepared for no estate tax, no Generation Skipping Tax, and carryover basis for those who die in 2010. This seems pretty simple, but is complicated by two major considerations: What will happen in 2011 if no legislation is forthcoming, and what happens if the Congress enacts legislation retroactively in 2010?
No estate tax in 2010
Assuming Congress does nothing, those who pass away in 2010 will not have to pay estate tax regardless of their level of wealth. In “Federal Estate Taxes Loom,” I described one of the implications of this as a possible “Throw Momma from the Train” scenario, as beneficiaries stand to receive larger inheritances without the bite of estate tax. Although I made light of it, the potential public policy implications of this alone should have been enough to spur Congress into action. Removing nefarious intentions from the discussion, should families make end-of-life planning decisions based on this potential financial windfall? Does anyone seriously want to talk about this with clients? Can we afford not to?
Another serious issue concerning the elimination of estate tax is more esoteric. In most estate planning documents, the funding of trusts is determined by “funding formulas.” Most of these formulas relate to the current estate tax. The idea is usually to fund trusts to a certain level to minimize or eliminate estate tax for those funds. The problem for people dying in 2010 is that their funding formulas will relate to an estate tax amount that doesn’t exist. As estate tax comes back with a vengeance in 2011, the funding formulas for these 2010 funded trusts need to work, or the surviving spouse may pay more estate tax than they would have to if funding formulas were not tied to 2010 estate tax levels. Wealth managers need to evaluate the need to amend revocable trusts so estate settlement and trust funding formulas are not stymied by a one-year lapse of estate tax limits.
No Generation Skipping Tax in 2010
Planning techniques for taking advantage of 2009 Generation Skipping Tax (GST), levels were discussed in “Federal Estate Taxes Loom.” Based on the increased probability of there being no GST next year, planners and clients need to decide if 2010 might be a better year to make multi-generational gifts, especially if the size of these gifts exceeds GST exemption limits. The potential for retroactive legislation once again complicates this planning issue.
Another huge issue for 2010 is the switch, from date-of-death step-up treatment of cost basis of assets, to a carryover basis treatment for inherited property from someone who dies in 2010. Generally, at the death of an asset owner, the cost basis of the asset has been “stepped up” to date-of-death value, allowing those who inherit these assets to sell them with little or no capital gain (or loss) consequence.
For assets of individuals who die in 2010, the survivors will inherit the cost basis as well as the asset, so any sale of that asset will be a taxable event. The idea, of course, is revenue production that is broader based than the estate tax. The problem is that carryover basis treatment has been tried before. In the Tax Reform Act of 1976, a carryover basis regime was passed, but Congress repealed it before it was put in place for fear that the recordkeeping and tracking issues would be so ponderous as to be insurmountable. We all know that many of our clients come to us without adequate basis information, and many hold assets until death to use step-up to “wipe the slate clean.” This common planning technique will not be available to those who die in 2010. Wealth managers should notify their clients that cost basis records should be organized and updated, just in case.