It’s the law

Repeal of estate taxes calls for a review of plans
By Amy Reid
Lombardo
&
amp; Gilles
Effective Jan. 1, the federal estate tax and the federal
generation-skipping transfer (
”
GST
”
) tax were repealed.
As a result, estate plans may need to be reviewed and changes
may need to be implemented.
Repeal of estate taxes calls for a review of plans

By Amy Reid

Lombardo & Gilles

Effective Jan. 1, the federal estate tax and the federal generation-skipping transfer (“GST”) tax were repealed.

As a result, estate plans may need to be reviewed and changes may need to be implemented.

Prior to January 1, the law provided for a $3.5 million exemption from both the federal estate tax and the GST tax; a $1 million exemption from federal gift tax; a maximum estate tax and gift tax rate of 45 percent; and a full step-up in basis of assets passing from a decedent to their heirs.

As of January 1, the federal estate and GST taxes have been repealed; the federal gift tax remains in effect although with a lower maximum tax rate of 35 percent; and the full step-up basis of inherited assets has been eliminated.  Absent Congressional action, on January 1, 2011, the federal estate and GST taxes will be reinstated at the 2001 level. That is, with only a $1 million exemption and a maximum tax rate of 55 percent for estate and gift taxes. That means many more estates will be subject to estate tax in 2011 than under the law as it existed on December 31, 2009.  This uncertainty in estate planning is completely unprecedented.

The repeal of the federal estate and GST tax in 2010 raises various issues for existing estate plans. For example, the wills or revocable trusts of many married couples provide for certain formula bequests in order to maximize estate tax savings upon the death of the first spouse.

With a formula bequest, the marital trust is often funded with the maximum amount necessary to avoid the imposition of estate tax with the balance going to the family trust. In 2010, with no estate tax, a formula funding like this could result in the family trust receiving the entire estate and the marital trust receiving nothing. 

This outcome may completely violate a person’s intent when creating an estate plan.

If the beneficiaries of the marital and family trusts are the same, then there may be no issue with the estate planning documents. 

However, a person may have different beneficiaries of the marital and family trusts, such as with a blended family or when a spouse is the beneficiary of a marital trust and a favorite charity receives the balance of the assets. If there are different beneficiaries of these trusts, then it is important to determine whether the documents continue to fulfill one’s original intent.

In other situations, however, a concern results from the repeal of the GST tax, thus rendering meaningless any references to the GST tax exemption in the estate planning documents. It is particularly important that estate plans be reviewed when the governing document provides that the GST exemption benefits one’s grandchildren directly with the balance primarily benefitting one’s children. 

While the repeal of the federal estate and GST taxes in 2010 raises various issues, it also offers certain wealth transfer opportunities for some families. In general, the use of grantor trusts, and in some very limited cases, gifts to skip-persons, may provide some opportunities for a person to minimize their estate and GST taxes. This depends, however, upon one’s tolerance for risk since no one knows whether Congress will pass a retroactive reinstatement of these taxes, nor do we know the potential level of reinstatement. 

One other consequence is that the estates of persons dying in 2010 will not receive a full basis step-up. The beneficiaries of these estates will have the same basis in the inherited assets as the decedent’s basis in the assets. It is important to retain all documents that establish the historic purchase price (and the cost of any improvements) to assets such as real property. 

This will likely involve going through the decedent’s records in order to obtain such documentation. As a result of the limitations on the step-up in basis, more taxpayers will be affected by a capital gains tax when they eventually sell the inherited assets than were affected by the estate tax itself.

Based upon the uncertainty in the estate and GST tax laws, a review of a person’s specific estate planning documents in light of these changes could help avoid unintended tax consequences. 

This column is the work product of Lombardo & Gilles, LLP, which has offices in Hollister and Salinas.  Amy Reid is an attorney with Lombardo & Gilles, LLP.  You may contact the author at (888) 757-2444 or [email protected].  Mail your questions to Amy Reid, It’s the Law, c/o The Pinnacle, 380 San Benito St., Hollister, CA 95023.