The Uncertain Death Tax
As a result of Congress’ inability to agree on a resolution of the Federal estate (a/k/a the “death tax”) and generation-skipping taxes, we began the year 2010 in a state of anarchy with respect to these taxes. As time passes, the situation only gets worse.
The root of the present situation began with the Economic Growth and Tax Relief Reconciliation Act of 2001 (the “2001 Act”). That legislation, among other changes, phased in a general reduction of the highest marginal Federal estate tax from 55 percent to 45 percent and an increase in the exemption amount from $1 million to $3.5 million.
The 2001 Act also provided that there would be no Federal estate or generationskipping tax after December 31, 2009. However, under a so-called “sunset” provision the 2001 Act would generally terminate as of the end of 2010. Thus, if no future legislation is enacted, the Federal estate and generation-skipping taxes would be reinstated as of January 1, 2011. That would reinstate, among other things, a $1 million exemption and a 55 percent top marginal rate.
Although most responsible tax practitioners, including this writer, believed that Congress would enact legislation to preclude a one-year repeal followed by a return to the prior estate tax configuration, Congress has failed to do so. This leaves taxpayers, heirs, tax practitioners, estate planners, etc. in a state of uncertainty and frustration. Some of the unanswerable questions are:
1. If someone dies in 2010, will his or her estate be subject to a Federal estate tax?
2. If someone dies in 2011 or thereafter, what Federal estate tax regime will apply, if any?
3. How does the Federal generation-skipping tax apply to direct skips, taxable terminations and taxable distributions during 2010? Should generation-skipping tax exemption be allocated to transfers made in 2010?
4. What is the income tax basis of assets received from a person as a result of his or her death in 2010? The prior law generally used the fair market value at the date of death, with certain complex exceptions. The 2001 Act provides that for property acquired from a decedent in 2010 its basis is the lesser of the basis of the property to the decedent or the fair market value on the date of death, with certain exceptions.
5. What Federal gift tax rate applies to taxable gifts made in 2010? The 2001 Act retained the Federal gift tax at a 35 percent top marginal rate for 2010, as opposed to a 45 percent rate in 2009 and a 55 percent rate in 2011.
6. How will the uncertainty relating to the Federal estate and generation-skipping taxes affect the actual disposition of one’s property at death? For example, many wills contain a formula disposition of assets to a credit shelter trust based on the amount of assets that can pass free of Federal estate tax. If there is no such tax, what happens?
7. If Congress passes legislation that imposes Federal estate and generationskipping taxes retroactively to January 1, 2010, will it be sustained by the courts?
8. What will be the impact of the absence of, or change in, the Federal estate tax on a state death or inheritance tax? For example, New York State imposes an estate tax,
generally based on the Federal estate tax law in effect on July 22, 1998, with a top marginal rate of 16 percent.
The various issues raised above, as well as many others, could have been avoided by the simple expedient of extending the Federal estate and generation-skipping taxes as they existed in 2009 until such time as long-overdue legislation is enacted. Without such legislation, taxpayers, estate planners, tax practitioners, other service providers and the Internal Revenue Service are left to speculate in a vacuum. In addition to confusion and complexity, this causes a wasteful use of private and public resources. It will also place additional burdens on our judicial system. Nevertheless, we seem to have a dysfunctional Congress that values partisan politics above common sense.
Given this unfortunate state of affairs, many taxpayers should consider revising their wills (e.g., via a codicil) to provide an alternative should death occur at a time when there are no Federal estate or generation-skipping taxes in effect. This is especially important when the absence of these taxes could materially alter how one’s assets will be distributed to a spouse, children, grandchildren and others. While life is complex and uncertain, we are now placed in a situation where planning for the disposition of assets to one’s loved ones is even more complex and uncertain. We should all hope that this state of affairs will be rectified shortly.
This publication is intended to provide general information to our clients and friends. It does not constitute accounting, tax, or legal advice; nor is it intended to convey a thorough treatment of the subject matter.