January 07, 2010
Literally, barring a late eleventh-hour passage of a critical extension by the U.S. Senate, the federal estate tax is repealed for decedents whose deaths occur in 2010. On December 16, 2009, the U.S. Senate failed to extend the federal estate and generation-skipping transfer taxes to 2011. The Economic Growth and Tax Relief Reconciliation Act of 2001 ("the 2001 Tax Act") repeals these taxes for decedents dying after 2009. Under the 2001 Tax Act, these taxes are reinstated for decedents dying after 2010 but with a $1.0 million applicable exclusion amount ("exemption amount") and a maximum estate tax rate of 55 percent. In other words, the law to be in effect after December 31, 2010, is the same law that was in effect before June 7, 2001. Senate Finance Committee Chairman Max Baucus (D-Montana) plans to have these taxes reinstated retroactively to include estates of persons dying after December 31, 2009.
In the meantime, how should estate owners proceed with their estate planning? Media misinformation, together with confusion among estate owners, is rife. Absent some spark of genius by a member of the Senate before midnight December 18, which is remotely unlikely, given that, during the past year, little, if any, genius has been evident in the halls of Congress, following are the facts regarding federal gift tax and basis of property received by a decedent’s heirs or beneficiaries after 2009:
(1) The federal gift tax is not repealed for gifts made after December 31, 2009 (i.e., during 2010) [IRC §§2210(a) and 2664 flush language and (d)]; and the maximum federal gift tax exemption amount is $1.0 million [IRC §2505(a)(1); the 2001 Tax Act, §§521(b), (e)(2)]. After December 31, 2009, the maximum federal gift tax rate will be the top individual income tax rate of 35 percent [IRC §2502(a)(2)]. REMEMBER: The $1.0 million gift tax exemption amount is the equivalent of a $345,800 gift tax credit; that is to say, this credit is applicable first to lifetime taxable gifts and then, to the extent any credit or all of the credit remains at the decedent’s death, against any estate tax liability. Alternately expressed, the amount of gift tax credit used to offset gift tax on lifetime taxable gifts reduces the federal estate tax credit amount on the decedent’s taxable estate. Thus, it is imperative that estate owners remember that the gift tax will continue to apply.
(2) Except as provided in regulations, the transfer of property to a trust will be treated as a taxable gift, unless the trust is treated as wholly owned by the donor or the donor’s spouse under the grantor trust provision of IRC Sections 671 through 678 [IRC §2511(c)]. Thus, gifts valued at more than $1.0 million made to charitable remainder trusts (CRTs) will be subject to federal gift tax, since CRTs are not "wholly owned" by the donor-grantor; that is, such trusts are not grantor trusts within the meaning of IRC section 671 [Rev. Rul. 77-285, 1977-2 C.B., ¶7 ("[Reg. §]1.664-1(a)(4) provides that, in order for a trust to be a charitable remainder trust, it must meet the definition of, and function exclusively as, a charitable remainder trust from the date or time of the creation of the trust. This section further provides that, solely for purposes of section 664 of the Code and the regulations thereunder, the trust will be deemed to be created at the earliest time that neither the grantor nor any other person is treated as the owner of the entire trust under subpart E, part 1, subchapter J, chapter 1, subtitle A."); Treas. Reg. §1.671-1(d) (Dec. 12, 1980)].
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(3) Under the 2001 Tax Act, step-up (step-down) in basis for property acquired from a decedent whose death occurs after 2009 is repealed. Such property, in the hands of the decedent’s heirs, beneficiaries or trustee, will be subject to modified carryover basis, which is the lesser of: (a) the adjusted basis of the decedent; or (b) the fair market value of the property at the date of the decedent’s death [IRC §1022(a)]—not the alternate valuation date. The decedent’s personal representative (executor/executrix) is allowed to increase (i.e., step-up) the basis in assets owned by the decedent and acquired by the decedent’s heirs or beneficiaries [IRC §1022(d)(3)(A)]. Under this rule, each decedent’s estate generally is permitted to increase (i.e., step-up) the basis of assets transferred by up to a total of $1.3 million [IRC §1022(b)(2)(B)]. The $1.3 million is increased by the amount of unused capital losses, net operating losses and certain built-in losses of the decedent [IRC §1022(b)(2)(C)]. In addition, the basis of property transferred to a surviving spouse can be increased by an additional $3.0 million [IRC §1022(c)(2)(B)]. Thus, the basis of property transferred to a surviving spouse can be increased by a total of $4.3 million [IRC §1022(c)(1)]. However, the additional $3.0 million adjustment to basis for property passing from the decedent spouse to the surviving spouse is only available if the property either passes outright to the surviving spouse or to the trustee of a qualified terminable interest property ("QTIP") trust [IRC §1022(c)(3)]. Nonresident aliens (non-U.S. citizens not residents of the U.S.) will be allowed to increase the basis of property by up to $60,000 [IRC §1022(b)(3)(A)]. After 2009, the $60,000, $1.3 million and $3.0 million amounts are adjusted annually for inflation [IRC §1022(d)(4)]. Finally, under the 2001 Tax Act, modified carryover basis is effective only for decedents dying during the calendar year 2010, unless Congress decides otherwise.
Observations:
(1) In order to obtain the additional $3.0 million adjustment to basis for property passing to a surviving spouse when the decedent spouse does not want his or her estate passing outright to the surviving spouse, the decedent spouse must direct in his or her Last Will, revocable living trust, irrevocable life insurance trust, grantor retained annuity or unitrust, qualified residence or personal residence trust (in the "fail-safe" Article) that the property passing to the surviving spouse be allocated to a QTIP trust—not for estate tax marital deduction purposes (if the federal estate tax is repealed) but for the purposes of obtaining the additional $3.0 million basis adjustment and for reducing or eliminating state inheritance and/or state estate tax.
(2) Heterosexual married spouses who, after enactment of the 2001 Tax Act, designed their Last Wills and/or revocable living trusts to accommodate their deaths if the federal estate tax were in effect or not in effect as of the date of death, that is, a Part I and a Part II disposition arrangement, should not amend those estate plans in view of repeal of the federal estate and generation-skipping transfer taxes. QTIP trusts, either for purposes of obtaining the estate tax marital deduction in the gross estate of the first spouse to die, or to obtain for the surviving spouse the $3.0 million additional basis adjustment, will continue to be needed.
(3) Given the uncertain environment in Congress, heterosexual married spouses would be well-advised, if they have not already done so, to amend their present estate plans if those estate plans were implemented before the 2001 Tax Act or if those estate plans do not provide for a Part I and a Part II disposition arrangement following enactment of the 2001 Tax Act.
(4) As I have previously discussed, even if the federal estate, generation-skipping transfer and gift taxes are repealed, estate planning is still needed for all of the nontax planning reasons. Telephone or e-mail me if you have any questions or want to arrange an appointment to review your present estate plan.
(5) For decedent’s dying before January 1, 2010, with estates subject to federal estate and generation-skipping transfer taxes, those taxes will still be imposed after December 31, 2009.
Doug H. Moy is a nationally recognized author, consulting specialist, seminar instructor and educator. He has an undergraduate degree from Willamette University and a Masters degree from Washington State University. Since 1979, Mr. Moy has consulted to attorneys, tax practitioners and their clients, as well as assisted practitioners representing clients before the IRS Conference of Right and Appeals Division and Settlement Conference Negotiations. He is noted for his ability to communicate his unparalleled knowledge and experience to practitioners at all levels in his field of expertise; namely, estate/gift taxation and planning, with special expertise in living trusts; community property; lottery prize winnings; structured settlement trusts; extricating clients from abusive trust tax shelters; designing effective estate plans; and preparation of Form 706 Estate Tax Returns and 709 Gift Tax Returns. He offers particular assistance and exceptional skill designing creative, practical solutions to challenging and difficult estate planning situations.