I am writing this post on Martin Luther King Day. I think about his courage, his character, his commitment to a greater purpose. Few of us can hope to achieve the sort of immortality and lasting impact of Martin Luther King. But we can be inspired by him. And we can find the courage to do difficult things because we know they are right. And in our daily lives, drafting an estate plan can be one of those things. It takes courage to contemplate the future, and to plan for unforeseen events. And to meet our fears or worries head on. But by making a plan now, you can be a hero to your own family. And leave a legacy that will comfort those who you love and care about.
And given the recent expiration of estate tax laws on January 1, 2010 and the confusing issues we face, it’s important to choose a trusted advisor who specializes in estate planning to navigate the muddy waters.
Estate Taxes
Estate tax laws expired on January 1, 2010 and there is no clear indication when Congress will address the issue. In 2009, there was a federal tax of up to 45% on estates valued at $3.5 million or more. Under a sunset provision in the law, the so-called death tax disappeared in 2010. But the tax will be reinstated in 2011 for estates over $1 million — and at a rate of 55%. Not only that, Congress could retroactively change it even after January 1 of next year (although this will not happen without some litigation, I’m sure. Plus, I’m pretty certain that there will be some loopholes).
As a background to the question of the estate tax, a measure was passed in 2001 by Congress that made big reductions in the federal estate tax, phased in through 2009, and then repealed the tax, for one year only, in 2010, with the tax reinstated in 2011. For years, legislators in Washington have said they would make sure the estate tax law didn’t disappear by the end of this year. But with health care legislation taking center stage on Capitol Hill, the full Congress has yet to address the estate tax. The House did pass a bill tackling the tax earlier this month, but the Senate hasn’t had time to consider the issue.
Generation Skipping Tax
With the expiration of the estate tax law, the generation skip tax also disappears. Generation skipping tax is the tax on transfers to grandchildren (and others who qualify as the next generation after your child) over a certain amount. Starting Jan. 1, individuals can gift to grandchildren and pay only gift tax on the money. But again, Congress could pass a law that is retroactive.
Step Up in Basis
Although the generation skipping tax is gone for the time being, there is a limited step up in basis ($1,300,000 for individuals and $3,000,000 for community property) which may mean capital gains taxes. This may affect more heirs than estate taxes. Before 2010, the basis of an asset belonging to a deceased person was stepped up to the fair market value at the time of that person’s death (no limit). For example, let’s that I died in 2009. I had bought a house for $20,000 years ago and when I died in 2009, the value of the house was $3 million. The basis on my house would not have been $20,000 but $3 million. Therefore, if my kids were to sell this house for $3 million, they would not have had to pay any capital gains taxes. But now, this step up in basis is longer allowed, so there will be capital gains tax. In my example, my kids would have a profit of $2,980,000 and they could only deduct $1,300,000 from the profit, so they have to pay capital gains tax on the balance which is $1,680,000.
What to do?
Confusing? Yes, it is. But this should not be a reason not to do estate planning. This just reinforces what I have been saying in previous posts that estate planning is not a cookie cutter approach and that one size does not fit all. This is the time when you need a qualified expert to help you through this labyrinth. For my clients, given the information at the time of the drafting, I have drafted your estate plan to take this year into account and with flexibility (but if your situation has changed significantly since the time that I drafted your plan, you may need to revisit your plan). If you’re not an existing client, this should provide a good reason for you to have it reviewed by an estate planning attorney, especially if your plan was written before 2001. If you do not have an estate plan, your estate plan should have language to take this year into account and also allow for disclaimers (you give up your right to own the asset owned by your deceased spouse, but it goes into a bypass trust which allows you to use it during your lifetime). If you experience death of a family member this year, you should go see an estate planning attorney and weigh the advantages and disadvantages of doing subtrust funding (you have 9 months to disclaim assets). If you want to give to your grandchildren, you might consider doing it sooner than later before Congress acts (but proceed with caution).
Again, estate planning needs to be customized. Finally, as I have written in previous blogs, there are many compelling reasons to draft an estate plan (to avoid probate, to avoid conservatorship, to protect your family and to ease stress). So don’t let Congress’ inaction stop you from acting – the reasons for doing an estate plan still exist, maybe even more today than ever.