Women, wisdom & wealth: Estate tax changes you need to know about

Having just returned from a four day meeting focused strongly on estate tax changes, I’d like to provide you with up-to-date information and some historic background. When Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) economists of the time were forecasting massive budget surpluses for the coming decade which was the foundation for the phased in reductions to the estate and gift taxes, eventually eliminating both and the GST effective Jan. 1. EGTRRA also included a sunset provision.

Until Jan. 1, almost everyone expected Congress to act to prevent repeal of the estate tax. Many expected a simple patch to extend 2009 law into 2010. In 2009’s cliffhanger of an ending, Congress instead offered no resolution at all, leaving investors in a precarious situation — how to design a financial plan that best suits their needs in what is perhaps one of the most uncertain, confused and confounding planning environments in history.

During the early 19th century wealth transfer tax was not a primary revenue generator for the government. Since that time, Congress has passed a series of legislation that alternately increases, decreases, eliminates and reinstates the various transfer taxes.

Year: Legislation

1797-1802: To cover expenses, a Federal Stamp Tax is imposed on certain estates. It remains in place until 1802.

1815: Congress debates an estate tax top finance the War of 1812.

1864-1870: Estate tax is introduced due to budgetary pressures from the Civil War.

1898-190: After several attempts by Congress, an estate tax is introduced on estates greater or equal to $10,000.

1916: Estate tax is levied on estates over $50,000.

1924: Estate tax is increased to 40$. Gift tax is added.

1926: Gift tax is repealed.

1932: Gift tax is reinstated.

1934: Estate tax increases to 60 percent for estates over $10 million.

1948-1953: Various bills increase and decrease estate and gift taxes. Estate taxes rise as high as 57.75 percent.

1954: Most employer qualified plans are exempted from estate taxes. By 1982, this exclusion is reduced to only $100,000. It is repealed in 1988 and a 15 percent excise tax is imposed that remains in place until 1997.

1976: Major legislation combines estate and gift taxes into a unified rate.

1986: Generation skipping taxes at a flat 55 percent rate are imposed and remain in place.

2001: Congress votes to gradually decrease estate taxes.

2010: Estate and generation skipping transfer taxes are scheduled for repeal.

2011: Under current law all estate, gift and generation skipping transfer taxes are scheduled to be reinstated at their 2001 rates.

Source: AXA/Equitable Flyer titled “Stop Ignoring Me. Estate Taxes Aren’t Going Away.” Catalog #137445 (9/09), http://tools.aimcoins.com/doclib/files/ AIMCO/39765/AXA%20-%20Estate%20Tax%20Repeal%5B1%5D.pdf.

Should I worry?

Regardless of whether you previously had in place a strategy for your estate, as of Jan. 1 your estate plan is probably outdated. Traditional estate planning documents refer to tax code concepts which no longer exist and apply tax strategies which no longer function as intended.

Formula clauses

Many modern estate plans used “formula clauses” to divide an estate at the death of the first to die of a married couple into two portions – one equal to the then-current exemption and the other set aside for the surviving spouse. These formula clauses are now, largely, obsolete.

Example: A popular formula clause provides for the maximum amount that can be transferred estate-tax-free into a “family trust.” The rest of the assets go into a “marital trust” for the surviving spouse’s benefit. If there is no estate tax, everything may go to the family trust. There will be nothing left to fund the marital trust.

Formal document review is highly recommended

The law today, and perhaps tomorrow, is unlike prior law. Estate planning documents should be reviewed by an estate planning advisor, including wills, trusts, pre- and post-nuptial agreements, and beneficiary designation forms. Even if you expect to outlive 2010, the future of your estate is uncertain.

Carryover basis

Prior to 2010, the law allowed for an adjustment in basis — a step-up — to the fair market value (“FMV”) of inherited capital assets. Basis is deducted from sales proceeds to calculate the tax gain or loss on the sale of a capital asset like a common stock. For 2010 only, the step-up has been replaced with a modified carryover basis (“MCB”), under which the heir’s basis will be the same as the deceased’s basis, unless the capital asset has depreciated in value. In that case, the heir’s basis will be reduced to the FMV as of the deceased’s death.

In addition to technical adjustments available in limited cases, there are two modifications to this rule. First, each estate is entitled to a basis increase of up to $1.3 million. Second, capital assets passing to a surviving spouse may be entitled to an additional $3-million basis increase.

Estates able to fully utilize both modifications will realize a maximum $4.3-million increase in basis (1.3 + 3). A married couple could realize a combined maximum $5.6-million increase in basis (1.3 + 3 + 1.3).

Carryover basis in a nutshell is simply the lesser of the deceased’s adjusted basis or FMV on date of death.

Modifications

Additionally, a limited increase in basis is available on certain transfers. An increase, or step up, of up to $1.3 million (“special adjustment”) is available to every estate. A reduced adjustment applies to non-resident, non-citizen heirs. Plus an additional $3 million (“spousal adjustment”) is available on outright transfers to a surviving spouse. Restricted to transfers outright (free of trust) and certain trust transfers.

In summary, comprehensive financial planning was significantly altered on January 1, 2010, with the temporary “repeal” of the estate and generation skipping taxes. While much remains undetermined, it is clear that these are interesting times rife with planning opportunities.

Action items

1. Obtain a formal review of all existing estate planning documents by your attorney, paying particular attention to any formula clauses employed.

2. Use the meeting with the attorney to update the estate plan to reflect changes in the family, changes in wealth, changes in goals or changes in fiduciary appointments.

3. Compile and share with your financial advisor a complete list of assets, including how the asset is owned (jointly, in trust, etc.), acquisition date and cost basis.

The information contained herein has been obtained from sources considered reliable, but we do not guarantee that the material is accurate or complete. Taxpayers should, and are advised to, seek advice based on their particular circumstances from an independent tax advisor.