Since 2001, when Congress changed the federal estate and gift tax law by instituting a system that set the "personal tax credit" (that amount that is not taxed since each individual is credited with the tax that would be paid on it) at $1 million, had it grow in steps to $3.5 million by 2009, completely repealed the estate tax for the year 2010, and then reverted to the 2001 law on January 1, 2011, estate planners (including me) have predicted Congress would adopt a permanent system prior to the one-year repeal in 2010. Under the 2001 law, the entire estate tax was eliminated in 2010—but the law said it came back at the 2001 level on January 1, 2011. This was a curious statute in need of fixing, they (we) said for ten years. The estate planners (including me) were wrong.
While there was no federal estate tax in 2010, throughout that year, the prediction was made with certainty that a repair would be made by June, then by September, and still nothing happened.
Then, last Election Day, President Obama and the Democrats in Congress took what the President described as a "shellacking." After the election and before transitioning to the current Congress, the Democrats passed a number of pieces of significant legislation to which Republicans objected. One major exception was legislation which extended the so-called "Bush Tax Cuts" for two years, thereby retaining lower income tax rates for all Americans regardless of income. This was supported by President Obama and Congressional Republicans, and opposed by the Democrats even though many of them held their noses and voted for it, extending the so-called "Bush Tax Cuts" for two years, in the face of significant opposition from Democrats, many of whom held their noses and voted for it. The major component of that was retaining lower income tax rates for all Americans, regardless of income.
Ignore for a minute the fact that the US has a huge deficit and debt, and the Bush Tax Cuts were originally passed in the face of a budget surplus that then President George W. Bush believed should be returned to the taxpayers, a situation that certainly did not exist at the end of 2010. That is a political argument, apparently for another day. What is important for estate planners, and for clients engaged in estate planning, is what the December legislation did about the estate tax problem—the potential return of the tax credit and tax rates at 2001 levels after ten years.
Various options were considered as tax package was discussed, including reverting to the 2009 system which had a $3.5 million individual tax credit for each person (which could result in $7.0 million being protected from tax if appropriate planning was done for a married couple) and a top tax rate of 45%, returning to the 2001 system with resulting additional revenue to the Treasury, or converting to some other system altogether. Most people predicted the first option would be the one selected. Again, they were wrong.
When President Obama and Republican leaders emerged from their negotiations, they proposed a vastly different system. The personal tax credit was increased to $5 million each, allowing a couple with $10 million in assets to leave them tax free. And, the maximum tax rate was reduced to 35%.
Predictably, most Republicans liked the new plan—they call estate taxes "death taxes" -- while most Democrats thought it protected the rich unnecessarily—they call estate taxes "wealth transfer taxes."
But, lost in this political debate was the fact that the proposed solution did not solve the problem because it did not recognize what the true problem of the prior decade had been. Sure, larger estates are protected from tax now than were protected in the past, which will be a relief to those couples with estates larger than $2 million or $7 million (depending on which of the other solutions would have been picked) but less than $10 million. However, one of the basic problems with the old system which remains today is lack of predictability. For the last ten years, estate planners have had to tell their clients that the tax liability of an estate depended on what year the client died! Readers probably remember those jokes about "not turning your back on your children in 2010".
The new law was enacted for two years. Estate planners can tell clients that $10 million per couple can be protected -- as long as they be sure to die in the next two years! No one knows what the system will be after that since the new law was enacted for only two years. Estate planning, unlike income tax planning for a particular year, usually is based on planning out in the future ten, twenty, thirty or more years. Predictability is important. Congress didn't get it.
What else did the new law do? It kept the 100% marital deduction, which means everything left to or for the benefit of a spouse is exempt from tax. It kept the stepped-up basis in assets after death. It retained the gift tax concept. It addressed an anomaly in the law about those persons who died in 2010, when there was no estate tax but when there was a limited step-up in basis on assets, and allows such estates to elect to be treated under the 2011 system.
What do the changes mean for you? For most clients who did estate planning to take advantage of two personal tax credits, no action is required as the result of the new law—at least for two years, when we go through this drama again. For those dealing with estates of persons who died in 2010, careful consultation as to what system to elect is important. If you have a question about how this affects you and your estate plan, call us—we can help!
For all clients, a new year is an appropriate time to take an inventory of personal and family assets, read existing estate documents to make sure they still conform with personal wishes in the event of death and accurately identify executors, guardians, trustees, agents, attorneys in fact and other fiduciaries, and make changes, if necessary. For those who do not have estate planning documents, it is a good time to act on that New Year's resolution to remedy the situation—by calling one of the members of the Estate Planning and Probate Department at Sheehan Phinney Bass + Green to have the documents prepared and signed.
This article is intended to serve as a summary of the issues outlined herein. While it may include some general guidance, it is not intended as, nor is it a substitute for, legal advice. Your receipt of Good Company or any of its individual articles does not create an attorney-client relationship between you and Sheehan Phinney Bass + Green or the Sheehan Phinney Capitol Group. The opinions expressed in Good Company are those of the authors of the specific articles.
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