Congress Apparently Fails to Prevent Repeal of Estate Tax in 2010
Late in the evening of December 16, 2009, the United States House of
Representatives adjourned for the Christmas Break and is not scheduled to
reconvene until January 2010. This means the estate tax and the
generation-skipping transfer (GST) tax will be repealed as of January 1, 2010,
as the Senate, although still is session, has yet to pass any legislation on
retaining the estate tax in 2010. On December 3, the House passed H.R. 4154
which would permanently extend the current estate tax law with a $3.5 million
exemption and 45% rate for estate, gift, and GST tax purposes. Although the
Democratic leadership subsequently tried to move a two-month extension of the
present transfer taxes in the Senate, it was unable to find the 60 votes
necessary for the bill to be considered. Most, if not all, of the Republican
Senators and some Democratic Senators (if they cannot achieve full repeal) would
like to see an increased exemption, such as $5 million, and a lower
rate, such as 35%. Even if the Senate acts before the end of the year (which is
unlikely at best), the House would not be in session to consider any bill passed
by the Senate. The only way that legislation could be enacted this year is for
the Senate to pass H.R. 4154 without any changes to the House bill. Given the
Senate’s refusal to pass a two month extension, this seems highly unlikely.
Many believe that legislation to permanently fix the estate and GST taxes
will be introduced in Congress early next year. However, because the current
estate tax law will expire January 1, 2010, that expiration will undoubtedly
create at least temporary uncertainty and confusion for many individuals in
planning their estates. The longer that Congress delays in enacting a solution,
the greater will be the uncertainty and confusion.
There are three possible resolutions to the current situation. First, if
Congress fails to act next year, the estate and GST tax regime in place prior to
2002 with a 55% rate, a 5% surcharge on estates between $10,000,000 and
$17,184,000, and a $1 million exemption will be reinstated on January 1, 2011.
During 2010, the gift tax will still be in place with a $1 million exemption but
a lower 35% rate.
Another possibly dramatic consequence of a failure by Congress to act next
year will be the substitution of a carryover basis regime for the repealed
estate tax. Under current law, a decedent’s heirs receive assets with basis for
computing capital gains taxes equal to the fair market value of the decedent’s
assets on the date of death. On the assumption that a decedent’s assets will
have increased in value between the dates of acquisition by the decedent and the
date of the decedent’s death, this basis adjustment is usually referred to as a
“basis step-up.” In 2010, if Congress fails to take action, the step-up in basis
goes away for one year and instead the heirs of a decedent take the decedent’s
basis in the property. This is often referred to as a “carryover basis.” There
are, however two major exceptions. The assets of every decedent will be eligible
for a $1.3 million increase in basis. In addition, assets passing to the
surviving spouse of a decedent will get an additional $3 million increase in
basis. These exceptions will prevent the imposition of carryover basis from
affecting many decedents, but others will be affected.
The second possible resolution is a temporary extension of some specified
duration of the current law with the $3.5 million exemption and 45% rate.
The third possible resolution is for Congress to enact some permanent fix for
the estate tax and the GST tax that will be effective in 2010 and beyond. Either
a temporary or permanent fix will probably require 60 Senators agreeing on the
fix with the likely areas of disagreement being the amount of the exemption and
the rate of tax.
If legislation is passed in 2010, one concern of some observers is whether
any legislation enacted next year to temporarily or permanently fix the estate
and GST taxes can be effective retroactively back to January 1, 2010. For
example, if Congress passed new estate tax legislation in February 2010 and
stated that the effective date is January 1, 2010, would an individual who died
in January 2010 be subject to the retroactively imposed estate tax or would that
individual’s estate escape estate tax but be subject to additional capital gains
tax because of carryover basis? There is no clear consensus on this and, if this
situation occurs, there undoubtedly will be litigation. Some may be tempted in
2010 to take advantage of the lower 35% rate for gifts (particularly those to
“dynasty” trusts) under the current law during the period before Congress acts
(assuming that Congress acts). Because there will be no GST Tax during this
window (assuming that any fix is not retroactive), one could, for example, gift
unlimited amounts to a trust for children, grandchildren, and more remote
descendants without GST tax consequences (although gift tax would have to be
paid once the $1 million exemption is exceeded, albeit at a lower 35% rate).
As can be seen, the legislative status of the estate and GST taxes is cloudy
with no clear resolution currently in sight. Individuals must carefully examine
their options in this confusing environment in planning their estates and they
should consult with their advisers before taking any steps. Because many estate
plans contain formula provisions tied to the marital deduction and to the estate
tax and GST exemptions, a careful review of all wills and trusts is appropriate
at this time. Advisers need to stay of top of the possible changes in Congress
to properly advise their clients. The McGuireWoods Private Wealth Services Group
is daily monitoring the status of the estate tax, gift tax, and GST tax in
Congress. We stand ready to help individuals and professionals understand and
work their way through the current legislative morass to find the appropriate
estate planning solutions.
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