ESTATE PLANNING BULLETIN, MARCH, 2010
Dear Clients and Friends:
As we have discussed with many of you, since 2001 the federal estate and generation skipping transfer (“GST”) taxes have been scheduled for repeal in 2010 followed by a “sunset” of the repeal in 2011 (returning the taxes to 2001 levels) – unless Congress agreed otherwise to modify the law. Contrary to the expectations of most observers, federal estate and GST taxes went into hiatus on January 1, 2010, when Congress failed to pass legislation addressing estate taxes. Thus, unless Congress takes action, we will have a one-year repeal of the federal estate and GST taxes followed by a return to 2001 law in 2011 and beyond.
Unfortunately, the failure of Congress to act leaves many of you with unresolved tax issues that could distort your estate plan if you (or your spouse) die during this period of uncertainty. The following is a summary of the situation:
Current Law
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No tax for 2010 decedents. This is good news, albeit temporary, and may be subject to retroactive action.
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Carry-Over Basis. This is bad news: the income tax basis of assets inherited from 2010 decedents will not be automatically adjusted or “stepped up” to the date of death value for larger estates. This lack of a step up means greater potential for capital gains tax, where applicable. The lack of step up is not universal: (1) a decedent’s personal representative/trustee will be able to allocate up to $1,300,000 worth of stepped up basis to estate assets; and (2) an additional $3,000,000 of basis may be allocated to assets passing to a surviving spouse or a qualifying trust for the benefit of the surviving spouse. Accordingly, new planning may be necessary if you are married and hold assets with more than $1,300,000 of appreciation – especially if age or health concerns merit particular focus in 2010.
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Formula Tax Planning for Married Clients. The new law impacts married couples with existing plans more than unmarried individuals. Many estate plans for married couples employ a formula that divides an estate into two portions: (1) a marital share that defers estate tax because it benefits the surviving spouse and (2) a non-marital share that is sheltered from tax by the estate tax exemption (whatever that amount may be at the time) and which may be applied for the benefit of descendants as well as a spouse (depending on the plan). In many cases, these existing plans will work just fine under the 2010 law. However, in some cases there may be serious unintended consequences, especially if there are different beneficiaries for the marital and non-marital shares. For example, if the spouse has no interest in the non-marital share, then the spouse may receive nothing because of how the formula creating the shares works. If you have concerns about the way your plan might work in the event of death in 2010, you should request an estate plan review.
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GST. The GST tax also expired as of December 31. Some estate plans provide that GST-exempt shares will be held in lifetime trusts for children which then pass on to the grandchildren, while the non-exempt shares are just gifted outright to children. With the GST in hiatus during 2010, there is no GST exemption to allocate and no GST tax. Therefore, such formula provisions may be meaningless and cause certain beneficiaries to receive a windfall while others receive nothing. Again, if you have concerns about the way your estate plan is drafted, please call us for a review.
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Oregon Inheritance Tax. Oregon Inheritance Tax continues in 2010, with a $1,000,000 threshold.
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Gift Tax. The federal gift tax continues in 2010. The lifetime exemption remains at $1,000,000 and the annual exclusion remains at $13,000 per donee. Gifts in excess of the annual exclusion must still be reported on a gift tax return. However, the top gift tax rate has been reduced from 45% to 35% for 2010. Oregon does not have a state gift tax.
2011 Sunset
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Reversion to 2001 Law. If no new estate tax legislation is enacted before January 1, 2011, we will return to 2001 law, which means the estate and gift tax exemptions will be $1,000,000, the GST exemptions will be $1,340,000, and the top estate, gift, and generation-skipping tax rates will increase to 55% (plus a possible 5% surcharge for the largest estates). Many estate plans have been drafted over the last several years when exemption amounts of $1,500,000, $2,000,000 or even $3,500,000 were in place at the time. A return to a $1,000,000 exemption amount may suggest a need for new planning for estates significantly over that amount in order to ensure optimal tax planning.
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Return of Stepped-Up Basis. The law allowing unlimited step up in basis to date of death value will return, no matter what the size of the estate.
Planning Opportunities
Despite current uncertainties, tax planning opportunities still exist. Interest rates (which change monthly) are at near historic lows, assets with the potential for appreciation have lost significant value in the last year or two, and traditional IRAs can now be converted into Roth IRAs thanks to new law now in effect. Some details:
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Low Interest Rates and Values. The current low interest rates make intrafamily loans and intrafamily installment sales particularly attractive. Similarly, current low asset values make gift giving strategies appealing, particularly if those assets are expected to appreciate in the future. This rationale applies not only to gifts that may be sheltered from gift tax by the $13,000 annual exclusion and the $1,000,000 lifetime exemption, but also for gifts that exceed those amounts and are thus subject to today’s reduced 35% gift tax rate. Direct gifts made to grandchildren are especially noteworthy because they are also free of any generation-skipping tax in 2010, but keep in mind that lifetime gifting is also particularly vulnerable to retroactive legislation, so thorough analysis and advice should be had before launching any aggressive gifting campaign.
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Roth Conversions. It is no secret now that conversions of traditional IRAs to Roth IRAs are available to everyone and may be a wise decision for income tax purposes, depending on the circumstances. However, you may want to consider that a Roth conversion also affords some significant estate planning opportunities. The power of tax-free compounding is such that even a modest conversion today can mean tax-free Roth distributions of hundreds of thousands of dollars to your children or perhaps millions of dollars to your grandchildren. To maximize the benefits of long term tax-free compounding, you might consider strategies such as: (1) paying the conversion taxes with non-Roth assets; (2) minimizing Roth distributions during your remaining lifetime; (3) leaving the Roth to your children, or even better to your grandchildren, in a manner that ensures they receive distributions over their lifetimes; and (4) providing in your trust that estate taxes (and if applicable, GST) attributable to the Roth are paid with non-Roth assets.
To ensure that your estate planning goals will be met, we would be happy to meet with you to review the current, though unsettled, state of the law and how it may affect your existing planning. We can discuss and assess with you the relative risks and benefits of making changes now or adopting a “wait and see” approach. Notwithstanding the uncertainty in the estate tax laws, we have attached a copy of our Estate Plan Review Checklist for your reference in determining whether review and updating of your existing plan would be appropriate.
Disclaimer
This bulletin is intended to alert you to the changes which took effect on January 1, 2010, and possible additional or prospective changes. It is a summary of general concepts and is not intended as a comprehensive explanation of the law or an assessment of your specific situations or needs. We have elected to highlight only those provisions which we believe may affect or be of interest to a large number of our clients. Any discussion of federal tax issues in this bulletin was not intended or written to be used, and cannot be used by you, (i) to avoid any penalties imposed under the Internal Revenue Code or (ii) to promote, market or recommend to another party any transaction or matter addressed herein. We have NOT reviewed your current estate plan or financial information with respect to the current state of the federal estate, generation-skipping, and gift tax laws. If you have questions or concerns about how the changes in the estate tax and related laws may affect your estate, please contact us to request a review of your documents and a conference with one of our attorneys.
Sincerely,
KARNOPP PETERSEN, LLP
Trusts and Estates Department
JAMES E. PETERSEN
THOMAS J. SAYEG
BRENT S. KINKADE
ERIN K. MACDONALD
JEFFREY E. ELLSWORTH