The Family Firm

As many know, we are currently in a "no man's land' with respect to federal tax law governing estate transfer.  Effectively, for the year 2010, previous federal estate tax law has been repealed.  Thus there is no federal estate tax for people dying in 2010.  Furthermore, starting in 2011, the federal estate law reverts to the law in effect in 2001, an exemption of only $1 million and a 55% tax on the excess.  For gifts, the lifetime limit remains at $1 million, but in 2010 the tax on gifts in excess of this amount is only 35%.  Next year this rate jumps to 55%.

The repeal of the federal estate tax in 2010 brought with it the reinstatement of the concept of "carryover basis".  Previously estate assets received a "step-up in basis", meaning that heirs received the assets free of capital gains (or losses).  This made it relatively easy to track the cost basis of inherited assets.  Now, instead of paying estate tax and getting a step-up in basis, heirs will inherit assets that retain the same tax basis the decedent had.  One exception to this rule is that up $1.3 million in appreciation can be waived (an additional $3 million of appreciation is waived if the assets are passing to a surviving spouse).

The uncertainty of federal estate law in 2010 (before December 31 Congress could decide to change rules retroactively to January 1, or not) leads us to several observations:

•    "Formula" clauses in wills could be disastrous for the surviving spouse this year.  For example, a clause like this: "give the maximum allowed without triggering an estate tax to X (e.g. my children from my first marriage, or to the by-pass trust, or to a trust for my sister, etc.) and give the remainder to my spouse", could leave the surviving spouse with no assets, under 2010 estate law.

•    Should an executor who may also be a beneficiary control how the $1.3 (or $3.0 million) of appreciation is allocated?

•    Since there is no generation-skipping transfer (GST) tax for generation skipping transfers that occur in 2010, generation skipping transfers may make more sense in 2010, especially if the federal estate tax exemption reverts to $1 million in 2011.

•    Because the estate tax could be retroactively re-instated in 2010, it is unlikely that families will want to take the risk of aggressive estate transfers in 2010.

•    On the question of prospects for finalizing the rules, this issue is a political football in a very partisan political climate.  Republicans are motivated to see a higher limit before the law reverts to a $1 million exemption in 2011, while Democrats are anxious for support from Republicans on any number of initiatives.  A late-2009 bill passed by the House died in the Senate.  Our understanding is that senators of both parties would like a higher exemption equivalent than the $3.5 million that existed prior to 2010.

We are reviewing with wealth transfer plans with clients and their estate attorneys.