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Federal Estate Tax

February 15, 2010

Happy New Year!

Never in my wildest of dreams would I have thought that I would be writing this letter to you.  No, I am not retiring as my three (3) adult children have taken my constant harping “YOU BETTER GET AN EDUCATION,” to heart.  What I am forced to do is write this letter about the shocking mess we find ourselves in because our Friends in Congress have permitted the federal estate tax to actually be repealed.  Some have called it Congressional Malpractice.

From the historical perspective, the Tax Reform Act of 2001 (“2001 Tax Act”) included phased increases in the federal estate exemption from $675,000 to $3.5 million per person and reduced the estate tax rate over time from 55% to 45%.  The key provision of the 2001 Tax Act was the actual repeal of the federal estate tax in 2010 – for one (1) year.  However, all of the provisions of the 2001 Tax Act sunset (expire) on December 31, 2010 and 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 tax will be reinstituted, the estate tax exemption will drop back to $1.0 million per person and the estate tax rate will be 55%.

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 tax receipts beyond ten years.  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 – $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.  However, leaders in the Senate indicated that upon their return in January, 2010, they would “fix” many of the expiring tax provisions.  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, such retroactive legislation will certainly bring numerous constitutional challenges.  While I must admit I missed most of my Constitutional Law classes (the Price is Right was much more exciting), I do remember something about the Due Process Clause of the 5th Amendment (“no person . . . shall be deprived of . . . property, without due process of law”).  So basically, we are in a no win situation and regrettably, we must understand where we are in 2010 and brace ourselves for 2011!

The following table illustrates where we were in 2009, where we are now, and where we will be in 2011.

2009 2010 2011
 Gift Tax Exemption(1) $1,000,000 less gifts made  $1,000,000   $1,000,000 less gifts made
   Maximum Gift Tax Rate  45%  35%   55% with 5% surcharge on giftsbetween $10,000,000 and $17,184,000
Estate Tax    Exemption (2) $3,500,000 less gifts made       Unlimited    $1,000,000 less gifts made
 Maximum Estate Tax Rate           45%           None       55% with a 5%   surcharge on estates between $10,000,000 and $17,184,000
 Exemption from  GST Tax (3)      $3,500,000       Unlimited    $1,000,000 indexed for inflation since 1999


(1)        Amount an individual may gift before the gift is subject to gift tax.  It does not include any annual exclusion gifts ($13,000/person/year).

(2)        Amount an individual may pass estate tax free on his death.  It is reduced by gifts made by the individual in (1) above.

(3)        The GST Exemption is the amount that an individual may leave in trust for a child/children that if in trust on the child’s death, will escape estate tax.

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 was 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.  Additionally, there are two (2) modifications to this harsh rule – one for property passing to anyone ($1.3 million increase) and one for property passing to the decedent’s spouse ($3.0 million increase).  Both of these provisions are elective by the decedent’s executor and will require the executor to file a Federal Estate Tax Return (Form 706).  This seems to be a remarkably stupid 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.  Do you think that anyone in Congress that voted for this provision actually thought about these consequences?  So much for simplicity!  The good news is that my favorite Treasury Department employee, “Turbo Tax Tim”, will be able to monitor this area.

Where does all of this leave us?  My recommendations are as follow:

1.         Review your existing Will – never hurts to do that anyway.  I am happy to visit with you.

2.         Consider making gifts in 2010 to children/grandchildren and tax them at 35%.  I would not do this until late 2010 – by then we should know what Congress is going to do with respect to 2010 and 2011.

3.         Pay attention to Congress and what our Friends in Washington are doing to the estate/gift tax system.  The later into 2010 the current system goes without getting fixed, the less likely we are to have any legislation at all.  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.

If you decide that you want to visit about your estate planning documents, please call Janet or Karla.  I will review them in advance and if I feel that any changes are necessary, I will prepare new documents for you to review and sign when we meet.  I am so offended that we find ourselves in this regrettable situation that I will not charge you for any time to prepare revised documents.  Instead, I will charge a de minimus flat fee to cover my administrative time to prepare your revised documents.  My sense now is that it will be in the $50 range.

I never thought we would be in this mess – but now that we are, we need to plan for it.  Sure makes me wonder if the “Byrd Rule” should be spelled with an “i”.


Robert J. Widmer, Jr.


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