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Highlights Regarding the Status of Federal Estate, Gift and GST Tax

Tuesday, Jan 26, 2010, 11:19AM

Introduction: the law before January 1, 2010.

For many years, and through December 31, 2009, the federal government imposed gift and estate tax on gift transfers made during life and at-death above a certain cumulative value. In 2009, every U.S. citizen was entitled to an exemption from gift tax of $1,000,000, and from estate tax, an exemption of $3,500,000 applied. (Qualifying lifetime or at-death gifts to charity and to or for a spouse also qualified for special deductions and were not subject to tax. Certain other gifts qualified for treatment as “nontaxable” gifts for gift tax purposes.)

Another tax, Generation Skipping Transfer (“GST”) tax, was imposed with respect to many gifts made to or for individuals who were more than one generation removed from the person making the gift. In 2009, every U.S. citizen had an exemption of $3,500,000 from GST tax.

Through December 31, 2009, subject to certain exceptions, assets an individual owned acquired a new basis for federal income tax purposes at the individual’s death. The new basis of an asset would generally be equal to its fair market value on the date of the owner’s death. This change in basis was commonly referred to as a “step up in basis” because often an asset owned by a decedent had appreciated between the date of its acquisition by that person and the date of his or her death. Thus, at the owner’s death, often the basis increased, or “stepped up” to a higher amount.

Current law, for 2010 only. Under law which “sunsets,” and effectively disappears at the end of this year, barring new legislation, for the year 2010 only, there is no federal estate tax, and no GST tax. During the same period, 2010 only, an individual’s assets do not automatically acquire a new basis at his or her death. Instead, subject to certain exceptions, assets retain the same basis they had in the hands of the deceased owner (and thus have a “carryover basis”), except to the extent the decedent’s executor allocates to such assets the “basis increase” amounts provided for under federal law. A general $1.3 million basis increase is available for this purpose, and a $3 million basis increase is also available with respect to qualifying gifts to or for the decedent’s surviving spouse.

Federal gift tax remains in effect in 2010, and the gift tax exemption remains $1,000,000. The tax rate for the year 2010, however, is 35%, rather than the 45% rate it has been for some time.

Life in 2011, under current law. If existing legislation remains unchanged, beginning January 1, 2011, federal estate and GST tax will spring back to life, but the exemption from each will be $1,000,000, not $3,500,000. The change in basis rules will return to their pre-2010 condition as well. Federal estate, gift and GST rates would be based upon a schedule with a maximum effective rate of 55%.

Possible legislative changes. Those of us who work in the estate planning field expected Congress to enact legislation before December 31, 2009, so that U.S. taxpayers would not face the possibility of no federal estate tax one year, followed by a return to an estate tax, but with a lower exemption than before, in 2011. A bill which would have extended the law in effect in 2009 did in fact pass the House in December, but not the Senate. It seems likely that new legislation will be proposed this year, and Congress could propose that such legislation become effective immediately upon passage, or on January 1, 2011 or some other future date, or even retroactively, as of January 1, 2010, although the constitutionality of the latter is unclear. In the meantime, U.S. taxpayers simply have to live with the law on the books.

What could this mean for an existing estate plan? Many existing estate plans base the value of gifts to beneficiaries upon the existence of federal estate and GST tax and the historic exemptions from estate tax, which increased over a number of years to the 2009 $3,500,000 limit. This may mean, for example, that more value will be allocated to a so-called “family” or “exemption amount” or “credit shelter” trust (designed to make use of the decedent’s exemption from federal estate tax) than the individual had in mind, and less to a “marital trust” which benefits only the surviving spouse during his or her lifetime. Some estate plans may take the 2010 law into account, but many, and perhaps most, do not. It is therefore important to consider whether existing documents should be revised to be sure that assets will be divided among beneficiaries in the shares, and with the effects, you had in mind.

This material is intended to provide an introduction to the topic involved and is not intended to serve as legal advice. It is important that you consult with an attorney, whether at Ransmeier & Spellman PC or elsewhere, and receive advice specific to your facts and circumstances.

364501; R 1/26/2010

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