Temporary Repeal of Estate and GST Taxes Creates Planning Concerns and Opportunities

Despite indications from congressional leaders that they would address the issue before the holiday recess, the federal estate and generation-skipping transfer (GST) taxes were temporarily repealed on Jan. 1, 2010.

As a result, unless Congress enacts new legislation, no federal estate tax will be imposed on the estates of individuals dying in 2010 and no GST tax will be imposed on transfers made in 2010. As the law stands now, both taxes will return on Jan. 1, 2011.

While this temporary repeal may appear to be good news for taxpayers, the repeal of these taxes comes at a price. Most notably, the income tax basis for property acquired from a decedent in 2010 will be the decedent’s adjusted basis in the property or the fair market value of the property on the date of the decedent’s death, whichever is lower.

This new provision, which is known as the “carryover” basis rule, replaces the “stepped-up” basis rule and may result in higher capital gains taxes being imposed when inherited property is sold.

Importantly, the “carryover” basis rule does allow a personal representative to allocate up to $1.3 million in increased basis to the decedent’s assets in general and, in certain circumstances, an additional $3 million in increased basis to assets passing to a surviving spouse who is a U.S. citizen.

The repeal of the federal estate and GST taxes may also have adverse impacts on existing estate plans. For example, many estate plans use formulas to determine the division of assets among different beneficiaries. These formulas are often based on the amount of the federal estate and GST tax exemption available in a given year.

Because the federal estate and GST taxes have been temporarily repealed, the formula used in a decedent’s estate plan may not allocate the decedent’s assets as originally intended if the decedent dies in 2010.

Moreover, due to the temporary elimination of the “stepped-up” basis rule, all estate plans should be carefully reviewed to ensure that the new “carryover” basis rule does not produce unintended results.

For example, estate plans should be reviewed to ensure that assets left to a surviving spouse in trust will qualify for the additional $3 million in increased basis available to assets passing to a surviving spouse who is a U.S. citizen.

Estate plans should also be reviewed to ensure that personal representatives and trustees have the appropriate authority and discretion to make any necessary allocation of increased basis that is provided by the “carryover” basis rule.

Despite these concerns, estate planning in 2010 is not all gloom and doom. While congressional leaders have stated their intention to reinstate both the estate and GST taxes at some point in 2010—and to make that reinstatement retroactive to Jan. 1, 2010—the temporary repeal of the federal estate and GST taxes may present planning opportunities for certain risk-tolerant individuals.

For example, the repeal of the GST tax, coupled with a relatively low gift tax rate (35 percent), may present a good opportunity for certain individuals to make gifts to grandchildren and other remote descendants.

Legislative uncertainty aside, this may also be a good time to consider certain lifetime giving strategies that are particularly effective in this climate of low interest rates and depressed market values. Such strategies include loans to family members, grantor retained annuity trusts and charitable lead annuity trusts.

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Peter R. Wand

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