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HORNE Tax Alert

Estate Tax Uncertainty in 2010 and Beyond

The federal estate tax rules changed radically on January 1, 2010. The rules could change again on January 1, 2011, unless Congress enacts new legislation. We encourage you to reevaluate your estate planning as soon as possible in light of this uncertainty.

Present Estate Law

On January 1, 2010, the federal estate tax was repealed for one year. The basis rules for inherited property changed from fair market value to carryover basis. While, there are certain special basis adjustments that may be elected, these are limited.

Effective January 1, 2011, the federal estate tax will be reinstated. The federal estate tax exemption will be $1 million and tax rates go up to 55% plus an additional 5% surtax on certain estates over $10 million.

Why did this happen?

In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (2001 Act) which provided for the phased-in increases in the federal estate exemptions and lower rates that we have seen through 2009.  The estate exemption had climbed in 2009 to $3.5 million per decedent with a flat 45% estate tax on estates in excess of this amount. Basis in inherited property was the fair market value on the decedent's date of death.

Because the 2001 Act reduced federal budget revenues, it had to contain a "sunset" provision that said that post-2010 estates have to be taxed as if the 2001 Act had never been enacted at all. This is why we are facing a $1 million federal estate tax exemption in 2011 and tax rates of 55%.

What happened in 2009?

Estate planning practitioners universally expected Congress to carry over the 2009 estate tax rules to 2010.  However, unexpectedly in December the House and Senate failed to act on any type of legislation - temporary or permanent. Therefore, effective January 1, 2010, there is no federal estate tax.

Why does a person need to re-evaluate his or her estate planning now if there is no estate tax?

If a person dies in 2010, he or she will not owe any estate tax, but assets may not be distributed to heirs as intended because of the pre-2010 language in his or her will or planning documents. Many documents contain what are referred to as "formula clauses" that set aside the amount of the estate equal to the current lifetime exemption in a "by-pass trust". This was done to maximize the use of both spouse's lifetime exemptions. Since there is no estate tax in 2010, this formula clause could inadvertently disinherit some heirs including a surviving spouse. It could create conflicts among family members on how the language in the documents should be interpreted and how the special basis adjustment rules should be applied to assets.

No estate tax sounds good, but the flip side is higher income taxes for heirs. Congress has indicated that in 2010 about 6,000 decedents will benefit from the elimination of estate taxes, but more than 70,000 heirs will pay higher income taxes because of the change in the income tax basis rules for assets received from decedents.

Is there legislation on the horizon?

We expect Congress to act in 2010 to address the estate tax issues. Possible actions by Congress could include:

  • Adopting a permanent estate tax exemption, beginning in 2010 or 2011. If so, most estate planning experts anticipate estate tax exemptions to fall between $2 -5 million and tax rates from 35% to 45%.
  • Adopting a temporary higher estate tax exemption.
  • Adopting rules to limit or eliminate valuation discounts.

2011 Forecast

Unless Congress enacts new legislation in 2010, a number of automatic changes occur to the federal tax code on January 1, 2011, including:

  • The return of the estate tax with a $1 million exemption per decedent and estate tax rates higher than the 2009 rate (e.g. 55% for estates above $3 million and 60% for estates above $10 million).
  • The return of the "step up" in basis of inherited property equal to the fair market value on a decedent's date of death.
  • An increase in the top individual income tax rate by at least 4.6%.
  • An increase in the capital gains tax rates from 15% to 20%.
  • Dividends being taxed at ordinary income tax rates rather than the capital gains rates. (There is current discussion in Washington to keep the dividend rates equal to the capital gains rates.)

Re-evaluate Your Estate Plan with HORNE

Unless Congress adopts new legislation, we'll go from no estate tax in 2010 to estate taxes in 2011-which are much higher than we have seen in recent years. Uncertainty makes it difficult to plan, but waiting to see what happens next is not a good option either. Flexible tax and estate planning is needed to respond to these changes. HORNE can review your current estate plan and make suggestions to help you minimize taxes and reduce the possibility of future family conflicts in these chaotic times.

HORNE's tax team is ready to discuss the changes and the impact on your situation. For more information, please contact your HORNE advisor or local office.