A $5 million estate tax exemption with a lower estate tax rate? Executive Branch vs. Legislative Branch? Democrats vs. Republicans? These are exciting times for estate planning enthusiasts. I have always wondered why there was never a “Law and Order” or “L.A. Law” type of show featuring estate planning lawyers. “No, Ms. Senior Partner, a disclaimer trust would be a heck of a lot better than a credit shelter trust in these uncertain times! If I’m wrong, then I don’t want to be right!” The scripts would write themselves!
Anyways, as triggered by a very nice conversation I had earlier today with Liz Skinner, a personable and knowledgeable financial reporter at Investment News, I would like to further explain the impact of some unresolved, yet vital, issues that are perhaps somewhat behind the scenes during this estate tax debate.
Step-Up in Basis
For many years up to and including 2009, beneficiaries were able to erase the capital gains of most property gifted to them by a decedent through an unlimited beneficial step-up in basis. Through this rule, the beneficiary would be able to assume that the tax basis (or purchase price) of inherited property was equal to the property’s value on the date of death.
However, when Congress allowed the estate tax to expire in 2010, the step-up rules changed. Now, a beneficiary is only eligible to exempt $1.3 million of capital gains, plus any property given to a surviving spouse can receive an additional capital gains tax exemption of $3 million. This resulted in some paying more in capital gains taxes in 2010 than they would have in estate taxes in 2009.
It has not been made clear what step-up rules will apply in 2011. The Wall Street Journal even reported that Congress might include a provision that would allow executors to choose between the 2010 and 2011 estate tax rules.
This year, there is a 35% maximum rate on gifts exceeding $13,000 to any individual. Due to the fear that the estate tax would revert back to 2001 levels (maximizing at 55%), many planners recommended that people nearing death give large gifts in 2010 in order to pay 35% instead of 55% in taxes.
Under the latest compromise, gift taxes and estate taxes will both maximize at 35%. However, until the bill passes, there remains the possibility of changes, especially given the level of dissent expressed by Democrat leaders.
This raises the rhetorical question of what dying individuals should do this month. Should they gamble that both taxes will stay at 35%? If a compromise results in the gift tax rate increasing, was the recommendation to make large gifts this year mistaken? If instead only the estate tax rate increases, should a gift be made in the next 22 days?
GRATs (Grantor Retained Annuity Trusts)
A GRAT is an ingenious tool used to remove assets from one’s estate. I will detail its mechanics in a future post. However, to summarize, GRATs receive property from an individual, and in return pay that individual an annuitized amount over a given number of years. If the individual dies before the end of that number of years, the GRAT fails and the assets remain in the individual’s estate. Based on a discovered loophole, many started to create GRATs that lasted for very short periods of time.
Congress has proposed that it will close the loophole with this upcoming tax bill. An interesting twist is that last week, the Senate attempted to pass the Middle Class Tax Cut Act of 2010, that would have applied tax changes retroactively to December 2. What happens to GRATs created this month? Will Congress even close the loophole? What if in two years, the estate tax is eliminated all together?
Finally, and possibly the most important concern of all, is how Congress will act to replace the billions of dollars lost by the eliminated / lowered estate tax rates of 2010-2012 (A thank you to “Jill”, who posted this concern in the Comments section of this blog’s previous post).
- Estate Tax Scramble (wills.about.com)
- 5M Estate Tax Exemption? But what about Stepped Up Basis? (floridaestateplanninglawyerblog.com)
- Obama Estate Tax Deal Would Hurt Estate Planners (lawprofessors.typepad.com)