Uncertainty of Federal Estate and Gift Taxs
As many of you are now aware from reports in the news and other sources, on January 1, 2010, there was a purported "repeal" of the federal estate tax (sometimes called the "federal death tax"). For a quick refresher, the federal estate tax is a tax imposed upon an individual for the "privilege" of transferring property at death and a federal gift tax is a tax imposed upon an individual for the "privilege" of transferring property during their lifetime.
When did this happen? Well, back on June 7, 2001, President George W. Bush signed into law the Economic Growth and Tax Relief Reconciliation Act of 2001 (commonly referred to as "EGTRRA"). This tax act contained many significant tax cuts one of which was a gradual increase in the estate tax exemption amount followed by a full repeal of the federal estate tax for decedents dying after December 31, 2009; provided, however, the federal gift tax would be retained with a $1,000,000 exemption amount and a top tax rate of 35%. Here's the catch. In order for Congress to have passed EGTRAA, they had to comply with certain federal budget guidelines which required EGTRAA to contain a "sunset" provision. EGTRRA's "sunset" date is December 31, 2010. Thus, the tax cuts contained in EGTRRA will expire on December 31st of 2010 unless Congress acts to extend these tax cuts.
Well, at least they got rid of the federal estate tax. What's the problem with that? Here's another refresher. Since the federal government was imposing a tax on the "privilege" of transferring property at death which was determined based upon the value of the property at the time of the decedent's death, the decedent's heirs received the property with a new cost basis equal to the value of the property on the date of the decedent's death. This is referred to as receiving property with a "stepped-up" basis. This would allow the decedent's heirs to dispose of the decedent's property and the pre-death asset appreciation would not be subject to a capital gains tax.
With the repeal of the federal estate tax, is there also a repeal of the "stepped-up" basis rule? Well, not exactly. EGTRAA contained a limited form of the stepped up basis rule. For property passing to non-spousal beneficiaries, the executor is permitted to increase (or step-up) the tax basis, on assets that are selected by the executor, with the total amount which can be allocated to assets passing to non-spousal beneficiaries capped at $1,300,000. For property passing to the surviving spouse, the executor can select assets to receive $3,000,000 in aggregate basis step-up regardless of whether the assets are transferred to the surviving spouse outright or in a marital deduction trust (or QTIP trust).
So, the federal estate tax is repealed for today, we have a limited basis step-up rule and there is still a federal gift tax, but what happens after December 31, 2010? If Congress does not act prior to December 31st, then the tax cuts contained in EGTRRA expire and we will return to the pre-EGTRAA estate and gift tax system with a $1,000,000 exemption amount and a top tax rate of 55%.
What is going on in Congress today to stop the EGTRAA tax cuts from expiring? In December, the House passed the Permanent Estate Tax Relief for Families, Farmers and Small Business Act of 2009 (H.R. 4154) which would have extended the 2009 federal exemption amount of $3,500,000 and maintained the top tax rate of 45%. H.R. 4154 was not passed by the Senate, so the federal estate tax was repealed on January 1, 2010.
Back in May, it was reported that Senator Max Baucus (D-Montana), Senator Jon Kyl (R-Arizona) and Senator Blanche Lincoln (D-Arkansas) supported estate tax reform by increasing the federal exemption amount to $5,000,000 per person and a maximum tax rate of 35%. What is complicating the estate tax reform process is that on February 5, 2010, Congress revived the pay-as-you go (or PAYGO) budget rules which in essence require that any revenues lost through tax cuts must be offset by other tax increases, spending cuts or other revenue increases, so any estate tax reform would have to be revenue "neutral" to comply with the federal budget PAYGO rules. This proposal by Senators Baucus, Kyl and Lincoln would require approximately $60 billion in revenue offsets or tax increases and finding tax increases acceptable to 60 Senators today would prove to be very challenging.
Is it possible that Congress could reinstate the estate tax with a retroactive effective date back to January 1, 2010? It is possible that the Congress could retroactively reinstate the estate tax, but there will certainly be some constitutional and other legal challenges made to retroactive tax legislation. Since it is now August and Congress still has not acted it becomes increasingly less likely that Congress will enact a retroactive reinstatement of the estate tax. Some commentators have suggested that if there is a retroactive reinstatement of the estate tax that Congress will make it optional. In order words, an executor could choose to pay estate tax and the decedent's heirs could receive the assets from the decedent with a "stepped-up" basis. This should alleviate some of the potential constitutional challenges anticipated with a retroactive reinstatement of the estate tax.
Other Miscellaneous Tax Rate Changes
What other tax cuts are going to expire on December 31, 2010? The 15% tax rate on qualified dividends and long-term capital gains is scheduled to expire on December 31, 2010. After 2010, dividends will be taxed at the taxpayer's ordinary marginal income tax rate and the maximum tax rate on long-term capital gains will be increased from 15% to 20%. Additionally, the qualified 5-year capital gains rate will be reinstated. Below is a chart reflecting the impending tax rate changes to ordinary income and capital gains.
|Ordinary Income |
Capital Tax Rate
|ST Capital |
|LT Gains |
|Ordinary Income |
Capital Tax Rate
|ST Capital |
|LT Gains |
Given our country's current economic circumstances and rising budget deficits, it is likely that we will see an increase in ordinary income tax rates and capital gains tax rates. If there is legislative reform with the estate tax it will most likely occur after the election. Many commentators believe that new estate tax legislation would have an estate tax exemption amount in the range of $3,500,000 to $5,000,000 with a top tax rate in the range of 35 - 45 %. The uncertainty surrounding the expiring tax cuts makes planning ones affairs very challenging.
If you have any questions regarding federal estate or gift tax planning for you and your family, please feel free to contact Howard Hoff or Eric Wilen for further information: (630) 655-6000.