Estate Planning Bulletin



Despite the predictions of most estate planners that Congress would “fix” the federal law taxing transfers of property, the estate and generation skipping taxes went into “hibernation” on January 1, 2010. Unless Congress takes action – either retroactively or prospectively — we will have a one year hiatus followed by a return to 2001 law in 2011 and beyond.

Regrettably, the failure of Congress to act leaves us with a number of unresolved tax issues that could distort your estate plan if you (or your spouse) die during this period of uncertainty. Here are the highlights:

The Law Today
  • No Estate Tax for 2010 Decedents. This is the good news.
  • Carry-Over Basis. Now for the bad news: the income tax basis of assets inherited from 2010 decedents will not be automatically adjusted or “stepped-up” to the date of death value. This means greater potential for capital gains tax.  The exceptions are: (1) the executor/trustee will be able to allocate up to $1,300,000 worth of stepped-up basis to the estate assets; and (2) an additional $3,000,000 of basis may be allocated to assets passing to a spouse or certain type of trust for the benefit of a spouse. Special planning may be necessary if you are married and hold assets with more than $1,300,000 of appreciation.
  • Formula Tax Planning for Married Clients. The new law impacts married couples more than unmarried individuals. Many estate plans for married couples employ a formula that divides an estate into two portions: one (the marital deduction share) that is sheltered from estate tax because it benefits the surviving spouse and the other (the exempt share) which is sheltered from tax by the estate tax exemption (whatever that amount may be) and which can be applied for the benefit of descendants as well as a spouse. In most cases, these plans will work just fine under the 2010 law. However, in some cases there may be serious unintended consequences. For example, if the spouse has no interest in the exempt share, then the spouse may receive nothing. If you have concerns about the way your plan might work in the event of death in 2010, you should request an estate plan review.
  • Generation Skipping Tax (“GST”). The GST also expired as of December 31. Many trust documents provide that GST-exempt shares will be held in lifetime trusts for the children which then pass on to grandchildren, while the non-exempt shares are distributed outright to children. With the GST in “hibernation” during 2010, there is no GST exemption to allocate and no GST tax. Therefore, such formula provisions may be meaningless and cause certain beneficiaries to receive a windfall while others receive nothing. Again, if you have concerns about the way your trust is drafted, please call us for a review.
  • Out-of State Property. California does not have a stand-alone estate tax. However, about half of states have adopted their own estate tax regimes, which will continue to apply to real property owned in such states — even if the decedent is a resident of California. Special planning may therefore be required if you own real property in one of those states.
  • Gift Tax. The federal gift tax continues to apply in 2010!  The lifetime exemption remains at $1,000,000 and the annual exclusion remains at $13,000 per donee. Gifts in excess of the annual exclusion must still be reported on a gift tax return. The top gift tax rate is reduced from 45% to 35% for 2010.
What Happens in 2011?
  • Reversion to 2001 Law. If no estate tax legislation is enacted before January 1, 2011, we will return to 2001 law, which means the estate and gift tax exemptions will be $1,000,000, the GST exemptions will be $1,340,000, and the top estate, gift, and generation-skipping tax rates will increase to 55% (plus a possible 5% surcharge for the largest estates).
  • Return of Stepped-Up Basis. The good news is that the rule allowing unlimited step-up in basis to date of death value will return.
While we wait…Planning Opportunities
Despite these uncertainties, tax planning opportunities still exist. The most appealing of these take advantage of the facts that 1) interest rates (which change monthly) are at or near historic lows, 2) assets with appreciation potential have had their values reduced significantly in the last year or two, and 3) a new law dealing with the conversion of regular IRAs into Roth IRAs is now in effect.
Our current low interest rate environment makes intrafamily loans and intrafamily installment sales particularly attractive. Current low asset values make gift giving strategies attractive, particularly if those assets are expected to appreciate in the future. This applies not only to gifts that may be sheltered from gift tax by the $13,000 annual exclusion and the $1,000,000 lifetime exemption, but also for gifts that exceed those amounts and are thus subject to today’s reduced 35% gift tax rate. Direct gifts made to grandchildren are especially attractive because they are also free of any generation-skipping tax in 2010 (absent any retroactive legislation).
            The popular press, banks, CPAs and brokers have well publicized that conversions of traditional IRAs to Roth IRAs are now available to everyone and, in the right circumstances, may be a wise decision for income tax purposes. However, we believe that a Roth conversion also affords some significant estate planning opportunities. The power of tax free compounding is such that even a modest conversion today (e.g., $50,000) can mean tax free Roth distributions of hundreds of thousands of dollars to your children or perhaps millions of dollars to your grandchildren. To maximize these benefits, you should (1) pay the conversion taxes with non-Roth assets, (2) minimize Roth distributions during your remaining lifetime, (3) leave the Roth to your children, or even better your grandchildren, in a manner that ensures that they receive distributions over their lifetimes (there are ways to do this) and (4) provide in your trust that estate taxes (and, if applicable, generation skipping taxes) attributable to the Roth are to be paid with non-Roth assets.
            To ensure that your family and charitable planning goals will be met, we would be happy to meet with you to review the current, if unsettled, state of the law and how it may affect your existing planning. We can discuss and assess with you the relative risks and benefits of making changes now or adopting a “wait and see” approach.
            This bulletin is intended to alert you to the changes which took effect on January 1, 2010, and possible additional or prospective changes. It is a summary of general concepts and is not intended as a comprehensive explanation of the law or an assessment of your specific situation or needs. We have elected to highlight only those provisions which we believe may affect or be of interest to a large number of our clients. Any discussion of Federal tax issues in this e-mail was not intended or written to be used, and cannot be used by you, (i) to avoid any penalties imposed under the Internal Revenue Code or (ii) to promote, market or recommend to another party any transaction or matter addressed herein. We have NOT reviewed your current estate plan or financial information with respect to the current state of the federal estate, generation-skipping, and gift tax laws. If you have questions or concerns about how the changes in the estate tax and related laws may affect your estate, please contact us to request a review of your documents and a conference with one of our attorneys.
Dickenson, Peatman & Fogarty,
Trusts and Estates Department:
David A. Diamond     Susan M. Teel
W. Scott Thomas       Francis J. Collin, Jr.
Julia M. Walk