The Sunset Provision of Estate Taxes How Much Tax Will Be Owed by the Survivors of Those Who Die in 2010?

Although most people involved in the estate-planning industry predicted that the government would change the estate-tax laws before Dec. 31, 2009, that has not yet happened. This was in anticipation that the government would want to prevent anyone dying in 2010 from having the significant benefit of the so-called ‘sunset provision’ on their estate taxes. However, the current unlimited exemption means that there is basically no estate tax due for a person who dies in 2010, regardless of who they leave the money to and how much money they leave.

The plan was to provide this exemption for only one year and then have the exemption revert to the $1 million exemption in 2011, and also to raise the tax rates to approximately 55{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} on assets in excess of $1 million passing to anyone other than a spouse.

By means of background, over the past 10 years, the exemption for estate taxes grew from $600,000 to $3.5 million. The $3.5 million exemption was available for anyone who died in 2009, exclusive of any assets passing to a surviving spouse who was a U.S. citizen, under the terms of the unlimited marital deduction, which basically means that there is no estate tax between spouses.

However, after all of the years of rising exemptions, for the exemption now to be reduced to $1 million is terribly regressive, and most of the legislators who were voting and debating this tax have assets in excess of those limits. Therefore, it was anticipated that it was unlikely that they would tax themselves as well as the rest of the citizens of the U.S.

As of now, Congress’ delay of this proposed law leaves everyone in a state of uncertainty. We do not currently know what the tax would be on the estate of someone who dies in 2010. There may be no tax at all, but Congress has discussed the possibility of passing a law affecting estate taxes that makes them retroactive to deaths occurring on or after Jan. 1, 2010.

Normally, when there is an estate tax due, both the tax return and the tax are required to be filed within nine months from the date of death. As of this writing (early July 2010), this lack of information and tight timeline makes it difficult for professionals to guide a family through asset settlement. It is unknown whether to tax them, select alternate valuation, or any other specific elections that may be available, such as disclaiming assets prior to the date that the return would have been due.

Perhaps Congress will provide a further extension of the nine-month period before enacting any retroactive legislation. There has also been discussion that an executor may either elect to pay a tax and include assets in the estate to receive what is known as the step-up in basis (or the date of death value), or, in the alternative, select the provisions of the law that were effective without any change, which means basically selecting the carry-over basis and not paying any taxes.

Carry-over basis means that heirs will receive property at the decedent’s tax basis, which is what the decedent paid for the asset, be it stocks, bonds, real estate, etc. A benefit of selecting carry-over basis is that there will be no estate tax due, but there will be an income tax due when the property is sold, presuming that there is a gain from the date that the decedent purchased the asset. The benefit of selecting the step-up in basis is that there will be little or no capital gains tax due if the property is sold, but there may be an estate tax due based on whatever exemption Congress decides on.

The forthcoming estate-tax exemption estimates have ranged from $3.5 million to $7 million. It is hoped that some agreement raises the limit significantly higher than the $1 million threshold. In addition, the issue of the tax rate is very important, since the rate in 2010 is a flat 45{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} on assets above $3.5 million, but the proposal is to reduce the rate to possibly the 35{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} range, as opposed to the previously enacted 55{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5} rate.

Although there is currently no estate tax in 2010, there is still the issue of gift taxes. You may wonder why a person may die and gift all of their assets away tax-free, but yet not have an unlimited right to give assets away during their lifetime. The reasoned decision to not eliminate gift tax is so that people may not give money away during their lifetime with unlimited amounts to the younger-generation individuals. Giving away money also reduces the income of the donor, and Congress does not want to reduce income taxes by shifting the income to a lower-bracket individual.

The gift-tax exclusions are currently $13,000 that a donor may gift to as many individuals in any one year as he or she desires without having to file a gift-tax return. This includes all gifts during the year, including birthday, anniversary, etc. Once that amount is exceeded, a donor has a lifetime exclusion of $1 million that they may gift, after which a gift-tax return is due to be filed, even if no tax is due. Until they exceed that amount, there is no gift tax due, but once that amount is exceeded, the gift-tax rate is 35{06cf2b9696b159f874511d23dbc893eb1ac83014175ed30550cfff22781411e5}.

The current confusion caused by the proposed, anticipated, and current status of estate and gift taxes will be enhanced when a new law is passed, prompting the need to revise estate-planning documents. At the current time, updated documents are taking advantage of any federal credits that may be available in the unfortunate event that the client dies in 2010 and the law is changed subsequent to their death. Documents may have to be revised when the current tax law is repealed and replaced with a new and improved estate-tax law.

Also, you must not forget that you are subjected to the estate taxes of any state in which you own property, so care must be taken to include provisions within the wills and trusts that will avail you of the credits and exemptions each state provides. In addition to reviewing documents, it is important to review the names, owners, and beneficiaries of all assets to assure that they are as you want them to be, since assets such as life insurance, retirement plans, and annuities have named beneficiaries that pass outside of probate and estate-planning documents. It is important to prevent an unintended result from naming incorrect beneficiaries.

All in all, a person who has greater than $1 million in total assets needs to review their plan with their professional advisor at this time, and possibly again when the law changes, to determine the most effective use of available exemptions in order to reduce estate taxes for their heirs. v

Attorney Hyman G. Darling is chairman of Bacon Wilson, P.C.’s Estate Planning and Elder Law departments, and he is recognized as a leading estate planner. His areas of expertise include all areas of estate planning, probate, and elder law. He is a frequent lecturer on various estate-planning and elder-law topics at local and national levels, and he hosts a popular estate-planning blog at bwlaw.blogs.com; (413) 781-0560;baconwilson.com