Here we are in late January, and we find ourselves between year-end tax planning and the actual filing period for most individuals. CPAs and wealth planners are working together to design an ideal strategy for their clients, and there is a crucial change in 2010 that will have a significant impact on the year: the temporary repeal of the federal estate tax.

Yes, the one-year disappearing act of the federal estate tax has come to pass. Some believe that quick action will be taken to reinstate the taxes at 2009 levels (see below bullets for details). Others believe Congress will proceed cautiously in an attempt to enact more sweeping reforms. In either case, any reinstated tax may or may not be made retroactive to January 1, 2010.

Needless to say, planning under these circumstances is challenging. Indeed, the failure of Congress to either extend the 2009 estate tax rules into 2010 or enact a permanent estate tax law has created a slew of unfortunate consequences. Some important pieces of the puzzle are:

- Both the federal estate tax and the federal generation-skipping transfer tax (a separate tax on property given to grandchildren, great-grandchildren, etc.) are repealed for 2010 unless Congress enacts legislation to reinstate them, retroactive to January 1, 2010 or otherwise.

- Both taxes are scheduled to return in 2011 at levels that applied prior to 2001. That means a $1 million exemption and a top tax rate of 55% (in 2009, the exemption was $3.5 million and the top rate was 45%).

- The federal gift tax remains in effect with a $1 million lifetime exemption, and the top tax rate has dropped to 35% in 2010 (versus 45% in 2009).  However, at this point in time the maximum gift tax rate is scheduled to jump to 55% in 2011.

Along with the repeal of the federal estate tax come new rules for determining the federal income tax basis of inherited assets which, if not changed, could mean heirs will pay more capital gains tax.  The old step-up in basis rule that allowed heirs to inherit property with a fair market value as of the date of death of the decedent has been modified. For 2010, the basis for inherited property is the lesser of the decedent’s basis (carryover basis) or its fair market value on the date of death. However, $1.3 million of estate property is afforded a step-up in basis, and up to $3 million of property passing to a surviving spouse receives a step-up as well.

While no one knows for sure what will happen to the estate tax, I think we can all agree that the indecision will make estate planning more challenging in the near term.  If your estate plan assumed that an estate tax would be imposed in 2010, it may no longer support the intended goals - it may not provide adequately for a spouse, and it may not meet overall tax objectives.

I have a few recommendations for first steps to take as we look for the best solution for each individual.

- A visit to your estate planning attorney might be in order to discuss the possible need to revise wills, trusts, and other estate planning documents.

- Getting records organized (both yours and your parents or grandparents) will also help the planning process; the modified carryover basis rules impose strict reporting requirements, including supporting documentation and penalties for noncompliance.

- It’s important to be careful not to ignore the impact of state death taxes.

This entry was posted on Tuesday, January 26th, 2010 at 8:00 am and is filed under Accounting, Wealth management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.