Congress has yet to amend the estate tax laws enacted in 2001. Accordingly, there is no federal estate tax imposed upon the estates of those who pass in 2010. If no new legislation is enacted this year, the federal estate tax will return in 2011, with an exemption of $1,000,000 only, and at least a 50% tax imposed on any excess value not passing to a surviving spouse or charity.

The most common estate planning strategy for a married couple for the last twenty-five years or more has been to divide the estate of the first spouse to pass into two portions. The assets constituting one portion are to have a value equal to the deceased spouse’s unused “federal estate tax exemption amount” ($3,500,000 in 2009). All other assets are allocated to the second portion. Neither portion will be subject to the federal estate tax when the first spouse passes even if there is a federal estate tax then in effect. The assets constituting the first portion normally pass to a trust for the surviving spouse and if they are held in that trust when the second spouse passes, there is no tax on those assets at that time either. This planning appeared fully appropriate before 2010 arrived, and appears fully appropriate for 2011 and subsequent years, but may not be appropriate if death occurs in 2010 for at least four reasons.

1) Construing documents which make reference to concepts that are irrelevant for the situation at hand may cause difficulty; in other words, if there is no federal estate tax, what is the “federal gross estate” or the “federal taxable estate”, and what constitute deductions against the federal estate tax, inter alia. Documents drafted at this firm should not suffer from these problems, but the same cannot be said for documents drafted elsewhere.

2) It may not be intended that all the assets of the predeceasing spouse pass to a trust for the surviving spouse.

3) There are very apt to be state estate tax concerns – assets passing to a typical trust designed to hold the “federal estate tax exemption amount” will be subject to state estate tax. This was not an issue previously, since the state exemptions were generally greater than the federal exemption, but it is a very big issue for 2010 deaths.

4) The generation-skipping tax has also been repealed for one year. Planning that makes use of the generation-skipping tax exemption may be complicated in unanticipated ways.
Another change relates to the income tax basis of inherited assets. Previously, the income tax basis of most assets has been re-set to the asset’s fair market value when the owner dies. But this year this automatic change in basis will not occur, and the deceased owner’s income tax basis in his or her assets will “carry over” to the new owner. Thus, upon the sale of the asset by the estate or a beneficiary, there may be significant taxable gain unless the executor is able to make elections which nullify this result.

This firm has developed language which merges optimal federal estate, state estate, and income tax planning, and which would protect against unnecessary taxation if death occurs in 2010 without requiring further amendment if the federal estate tax laws return.

Should you wish to discuss these matters, please call to schedule a meeting with an attorney in our Trusts and Estates Department.