I never thought the U.S. Congress would leave taxpayers hanging as it did at the end of 2009, particularly with respect to the status of the transfer tax system. The Senate got so hung up on healthcare legislation at the end of the year that it did nothing regarding tax legislation sent over from the House. The effect was to let the estate and generation-skipping tax expire for 2010.
From a historical perspective, the Tax Reform Act of 2001 (2001 Tax Act) included phased increases in the federal estate and generation-skipping transfer tax exemption from $675,000 to $3.5 million per person and reduced the estate and generation-skipping tax rate over time from 55% to 45%. The key provision of the 2001 Tax Act was the actual repeal of the federal estate and generation-skipping tax in 2010 for one year. All of the provisions of the 2001 Tax Act sunset (expired) on December 31, 2010, however. After that date, the tax law “shall be applied as if the 2001 Tax Act had never been enacted.” This means that on January 1, 2011, the federal estate and generation-skipping tax will be reinstituted, the estate tax and generation-skipping exemption will drop back to $1 million per person and the tax rate will be 55%. Horrible result!
The reason that the Republican controlled Senate in 2001 was not able to permanently repeal the federal estate tax was due to the Byrd Rule (named after Senator Robert Byrd). This rule requires a 60-vote approval in the Senate when a law is going to reduce taxes beyond the 10th year. In 2005, 2006, and 2007 Congress tried to find a permanent fix to this problem. In December 2009, the House passed a Bill making the 2009 law, a $3.5 million per person exemption and a 45% tax rate, permanent. The Senate had a similar Bill but failed to pass it before it adjourned for Christmas. Leaders in the Senate indicated that upon their return in January 2010, they would “fix” many of the expiring tax provisions. At this point, we can only speculate as to which provisions, if any, will be “fixed.”
Compounding the problem is the notion of retroactive tax legislation. If Congress reinstitutes the $3.5 million per person exemption now and makes it retroactive to January 1, 2010, (which is not at all certain) such retroactive legislation will certainly bring numerous constitutional challenges that will take years to work their way through the court system, probably going to the U.S. Supreme Court. While there is precedent for retroactive tax legislation, my readings of the prior cases suggest that they did not deal with new law, but rather with tweaking existing law. Some legal experts with whom I have spoken indicate that reintroducing an estate and generation-skipping tax law retroactive to January 1, 2010 would be new law and the prior precedents would not apply. Equally (or perhaps more) confusing would be immediate passage of legislation reinstituting the $3.5 million per person exemption, but making it prospective to some future date, say June 1, 2010. While the law may then be certain, it would leave estates of individuals dieing in the “gap period” of January 1 – May 31, 2010 in a very different estate and income tax position from estates of identically situated individuals dieing after May 31.
The following table illustrates where we were in 2009, where we are now, and where we will be in 2010 if Congress does nothing.
An additional complication we will face in 2010 is the concept of a modified carry over basis system. Prior to 2010, the beneficiary of a decedent’s estate inherited assets with a basis for computing capital gains equal to the fair market value of the assets on the date of the decedent’s death. This concept is frequently referred to as a “stepped-up” basis. In 2010, a new rule provides that the beneficiary’s basis in inherited property will be the lesser of the decedent’s basis or the fair market value of the property on the date of the decedent’s death. This concept is frequently referred to as a “carryover” basis. Congress tried “carryover basis” in the early 1970′s and it failed miserably and was retroactively repealed. Additionally, there are two modifications to this harsh rule – one for property passing to anyone (a $1.3 million increase) and one for property passing to the decedent’s spouse (a $3 million increase). Both of these provisions are elective. This seems to be an unusually severe provision because even though no Form 706 is required to be filed as no estate tax is due, every estate will have to file the Form 706 if the beneficiaries want to receive a step-up in basis for their inherited property.
Where does all of this leave us in 2010? My recommendations are as follows:
(1) Have your Will reviewed by a good estate tax attorney. If you don’t know one, I’ll be glad to give you some names.
(2) Consider making gifts to children and grandchildren and pay a 35% gift tax. I recommend, however, that you not do this until late in 2010. By then, we should know what Congress is going to do with the transfer tax system for 2010 and 2011.
(3) Pay attention to what Congress does with this issue during the remainder of this year. The longer the current system goes without getting fixed, the less likely we are to have any legislation in 2010. Tax reform in an election year is dangerous and most often not done. Also, given the current deficit, it will not be very popular to give “the rich” a tax break.
Sorry I don’t have better news for you. Congress has really left American taxpayers in a pickle! I’ll keep you posted on new developments.
Ronnie
Copyright 2010 Ronnie C. McClure, PhD, CPA
