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Federal Tax Law Summary 2010

12/29/2009 Articles

As many of you have heard, Congress did not pass new estate and gift tax laws before the end of 2009.  As a result and as of January 1, 2010 the federal estate tax and generation-skipping transfer tax have both been repealed, but only for 2010. 

This letter is intended to serve only as a summary of the major changes in federal estate and gift taxes.   We urge you to keep abreast of the news and to contact us, your CPA, or other financial advisor to determine how these changes in tax laws may affect you and your family.

Currently, and until there is a change in the federal laws dealing with these taxes, federal estate and gift tax laws provide as follows:

Federal Tax Law Summary:

Prior Year - 2009:     

$3.5 million estate tax exemption, with amounts in excess taxed at 45%.
$3.5 million generation-skipping transfer tax exemption, with excess taxed at 45%.
$1.0 million gift tax exemption, with excess taxed at 41-45%.

Change in income tax basis on assets included in a decedent's taxable estate to value on decedent's date of death (commonly referred to as "step-up in basis upon death").

Under this regime, a small percentage of decedent estates were actually subject to the filing requirements or paid estate tax.

This Year - 2010:      

No federal estate tax.
No federal generation-skipping tax.

$1.0 million gift tax exemption, with amounts in excess taxed at a rate equal to the highest marginal income tax rate (now 35%).

Carry-over income tax basis for assets transferred at death, with:

(a)        an aggregate basis increase of $1.3 million, allocated by the estate representative among the decedent's assets; and

(b)        an aggregate basis increase of $3.0 million to property inherited by a surviving spouse, outright or in trust. 

Under this regime, executors will need to file returns to allocate basis.

Note:  In order to allocate $1.3 million in aggregate increase in basis to assets, it will almost always be necessary to allocate substantially more than $1.3 million in assets to the intended beneficiary or the recipient trust.

Next Year - 2011:

$1 million exemptions for estate tax, gift tax, and generation-skipping transfer tax.
Estate and gift tax rates of 55%, with additional 5% surcharge on large estates.
Change in income tax basis on assets included in a decedent's taxable estate to value on
decedent's date of death.

For those of you who are California residents, the state does not impose any estate, gift, or generation-skipping tax.  However, other states do impose such taxes, each under its own specific laws.  Therefore, those of you who are residents of other states, or who have substantial holdings in other states, should seek advice to determine what estate and gift taxes may apply to those assets under the laws of the appropriate state. 

In light of these tax law changes, what should you do?

A new retroactive tax law?  There is a general expectation that Congress will pass a new tax law, sometime in 2010, to retroactively reinstate the estate and gift tax regime in a form similar to that of 2009 (described above) with the possibility of increases to the exemptions and deceases in the tax rates.   So be aware of changes that may be happening in the next several months.  It may take several months for this issue to be resolved.

Changes to your estate plan under the 2010 tax law. You should review your estate plan now to determine how your estate will be taxed and distributed if you were to die in 2010 while the new tax law is in effect.  The overall structure of your plan may need to change in substantial ways to take advantage of the income tax basis rules that will become the dominant theme of taxes imposed at death, and to avoid outcomes that you did not intend.

It is especially important to review your estate plan to confirm the amounts that will pass to your selected beneficiaries upon your death.  This is most critical for those of you who split your estate at the time of your death (a) between your surviving spouse and your children, (b) between your family and charity, or (c) between various beneficiaries, by using "measured" or "formula" gifts.  Such gifts are often measured by reference to an estate, gift, or generation-skipping tax exemption that no longer exists in 2010.  For illustration purposes only, a person may have provided that, upon his death, his children would receive "the maximum amount that can pass without the imposition of federal estate tax", with the balance to pass to his surviving spouse.  In that case and if the person were to die in 2010 when there is no estate tax, his entire estate would pass to his children, much to the chagrin of his surviving spouse.

Be ready to determine income tax basis of assets if current law is retained.  If the current 2010 tax law remains in place, the need to be able to determine the income tax basis of each and every asset owned by a person at death will become all the more important.  The executor of an estate will need this information to allocate the $1.3 million in basis increase to assets passing to the estate's beneficiaries outright or in trust, and to allocate the additional $3.0 million in basis increase to assets passing to a surviving spouse.

We are available to discuss these changes with you, and you must contact us if you would like us to review your estate planning documents.  Be aware that we do not know if the federal estate and gift tax laws will remain as scheduled for 2010, or if they will be reinstated to a system much like the one that applied in 2009.   We are all in uncharted waters at this point!