Estate Tax Issues for 2010-2011: What Will Congress Do (or not Do) Next?

      Back in 2001 when Congress enacted the 2001 Economic Growth and Tax Relief Reconciliation Act (EGTRRA) which included repeal of the federal estate tax for the year 2010, few people, if anyone, believed that the estate tax would actually be repealed. Most discussions of the 2001 law focused on the gradual increase in the exemption amounts and the gradual decrease in the tax rates. Rarely did people consider the issue of how to draft estate plans to deal with the one year repeal of the estate tax or the intricacies of the application of the modified carryover basis system that was part of EGTRRA. It was expected that the law would be changed well before 2010 so there would never be a repeal of the estate tax and there would never be a carryover basis system.

      Well, Congress surprised us all by failing to change EGTRRA. As a result of Congressional action (or inaction), we now have the following estate, gift, generation skipping transfer tax scheme and carryover basis system (of sorts) for 2010:

• There is no federal estate tax on the estates of decedents dying in 2010.
• The federal gift tax exemption remains at $1,000,000 with a top tax rate of 35%.
• The federal generation skipping transfer tax is repealed for transfers taking place in 2010.
• Property inherited from an individual who dies in 2010 will have a carryover basis, meaning that the recipient of the property will maintain the decedent's basis in the property (unless the property is worth less than the basis). However, the executor of the estate can allocate up to $1.3million of additional basis to the estate assets. In addition, for assets passing to a spouse, basis can be increased by up to $3million.

      It is important to remember that these changes are temporary because EGTRRA sunsets (ends) at the beginning of 2011 and the estate tax, as it existed in 2000, returns at that time. This means the federal estate tax will apply for individuals who die in 2011 with an exemption of $1,000,000 and a top tax rate of 55%. The generation skipping tax reappears as well and the carryover basis system vanishes.

      There is much speculation about what Congress will do regarding the estate tax. It is possible that the estate tax exemption of $3.5million and highest tax rate of 45% that were in place in 2009 will be reinstated retroactive to January 1, 2010. On the other hand, Congress might do nothing about the estate tax and have the $1million exemption and top tax rate of 55% return next year. As we have learned from recent experience, it is impossible to predict with any certainty what Congress will do!

      In addition to the current uncertainty with the federal estate tax situation, Connecticut has modified its state estate tax for 2010. As on January 1, 2010, Connecticut has an exemption of $3.5million and the tax rates have been reduced by 25%, so the current rates vary from 7.2% to 12%.

      Because of these changes in the tax law, you should review your estate plan. You might want to consider making gifts to take advantage of the lower gift tax rate (35%) and the lack of a generation skipping transfer tax for the year 2010, if in fact Congress does not change the current law.

      Moreover, because of these changes in the tax law, your current estate plan may not distribute your assets as you wish. For example, if you have an estate plan that leaves all assets that can pass free of federal estate tax to a trust for your children and the balance of your assets to your spouse, you could inadvertently be disinheriting your spouse. As another example, if your estate plan includes a bequest of the balance of your generation skipping transfer tax exemption to your grandchildren, you could inadvertently be giving your entire estate to your grandchildren.

      In light of the current tax situation, it is important that you contact your estate planning professional to review your current plan to determine if any changes are necessary. The attorneys in our Trusts and Estates Department are ready to help advise you in these uncertain times.