New Estate Tax Laws

It has been a while since my post regarding 2010's estate tax uncertainty. Without a doubt, few people - if any - accurately predicted what Congress would do. Not surprisingly, the uncertainty will continue, at least through 2012, when Congress will - hopefully - once again revisit the issue.

In the meantime, here are a few of the highlights from the new legislation:

• Default estate tax exclusion for decedents who passed away in 2010 is $5M.
  
• For decedents who passed away in 2010, an option is available to choose "carryover basis" (with step-up of $1.3M) instead of estate tax. Such an option could be useful when a decedent's estate exceeds $5M in value and liquid assets are unavailable to pay estate tax that may be due. However, in the vast majority of situations, taking the default $5M exclusion and the full "step-up" in basis will be the best option.
  
• Portability! The most useful and exciting change to the estate tax laws, in my opinion, is the new "portability" of estate tax exclusion amounts. This allows a married couple two opportunities to access both spouses' exclusion amount. For example, if Spouse A passes away leaving a $3.5M estate, and Spouse B subsequently passes away, leaving a $6.5M estate, neither estate will be subject to estate tax. Why? Because Spouse A has a $5M exclusion. Because Spouse A's estate only used $3.5M of the exclusion, $1.5M was "left over" and will be applied to Spouse B's estate, giving Spouse B an exclusion of $6.5M.
  
• A close runner-up to Portability, as an exciting new change, is the move from a $1M tax-free gifting cap to a $5M tax-free gifting cap (applicable only in 2011 and 2012). This increased gifting cap provides an excellent opportunity for families to reallocate assets to various estate planning vehicles, such as Irrevocable Life Insurance Trusts, Family Limited Partnerships, Grantor Retained Annuity Trusts, and Grantor Retained Unitrusts.

While the 2010 Tax Act brings good news for most moderate and high net worth individuals, the good news is tempered by the fact that Congress, once again, has given us temporary rules. Unless Congress acts again before 2013, the Estate Tax laws will revert to the laws applicable in 2000, with a $1M exclusion and a $1M tax-free gifting cap.

So what does all of this mean?

First and foremost, there are excellent tax planning opportunities during the next two years, that may disappear on January 1, 2013, so taking steps to plan now is highly advisable. The ability to transfer up to $5M tax-free to a tax planning vehicle should not be lightly passed up, as this opportunity may very well be "for a limited time only", and may revert to the $1M limit in 2013.

Second, it is advisable that all Estate Planning documents (particularly Revocable Trusts and Wills) be carefully reviewed to ensure that they continue to meet a client's wishes. Many Wills and Trusts are drafted with so-called "formula clauses". These provide for gifts to heirs based on a specified formula, which is often tied to the Federal Estate Tax laws. Because of the ongoing changes to Federal Estate Tax laws, gifts to heirs could also be changing, unbeknownst to the client!

For these reasons, I strongly encourage everyone who has (or should have) an Estate Plan in place to consult with their Estate Attorney, CPA, and Investment Advisor to ensure that their estate plans are still consistent with their wishes and effectively take advantage of the variety of available tax planning opportunities.

2010 Estate Tax Issues

This year is a year of "unknowns" when it comes to Estate Taxes. What is the total Gift and Estate Tax Exemption? Will there be a retroactive tax? Will assets receive a step-up in basis? What is the applicable Gift Tax rate? Under the current law, what will the Gift and Estate Tax Exemption be in the future?

Answers to these questions lie primarily with Congress, and I expect that we will have them by the end of the year. However, there is an additional twist that could cause the confusion surrounding these questions to be drawn out into next year or even later. I'm referring to the Constitutional prohibition against ex post facto laws (laws enacted after the fact to apply retroactively). While the Supreme Court has previously upheld laws imposing retroactive taxes, there are many who question whether the current Court will do so in this case.

This uncertainty leaves us in a state of flux. Most tax professionals believe that Congress will enact legislation that will be substantially similar to the estate and gift tax laws which were applicable in 2009. In other words, all assets will be eligible for stepped up basises and the individual estate tax exemption will be in the $3.5M range. Because the vast majority of estates are valued at under $7M (for couples) or $3.5M (for individuals), legislation which retroactively brings back 2009's laws would benefit most estates.

"But wait, I thought there are NO ESTATE TAXES in 2010?" How is a retroactive tax beneficial? Good question. In itself, it isn't. What is beneficial is the Estate Tax's step-sister: the unlimited step up in basis which reduces or eliminates capital gains taxes. Currently, non-spousal beneficiaries of an estate are only entitled to step up $1.3M in estate assets.

What this means is that, in an estate valued at $3.5M, containing primarily highly appreciated assets, the heirs could face significant and unexpected tax liability in the form of capital gains taxes on up to $2.2M!

In light of the current uncertainty, my best advice is to discuss your situation with your attorney, CPA, and financial advisor, and do your best to stay healthy and alive through 2010.

Probate Basics

"Probate" is a legal process through which assets are passed, typically with at least some court supervision, to a person's heirs. With limited exceptions, Probate is necessary to pass assets which have not otherwise been legally designated to pass to named beneficiaries.

A Probate estate will usually include personal property, such as money in the bank, jewelry or a car. It can also include real property, such as the person's home.

A Will is often used to direct distribution of assets through the Probate process. Where a valid Will exists, the beneficiaries named in the Will are entitled to receive the distributions designated in the Will. Otherwise, the estate will be divided among the person's heirs under California law.

Unfortunately, the Probate process is tedious and time consuming, so having professional assistance (or at least guidance) is practically essential.

"Trust Administration" is the term used to refer to the process of administering a trust. Usually this consists of paying estate debts and distributing assets to the trust's beneficiaries. It is generally considered to be less tedious and less time consuming than formal Probate, though getting professional guidance at the outset is always a good idea.

For more general information on the Probate process, I recommend reviewing the Sacramento County Superior Court's discussion, found at http://www.saccourt.ca.gov/probate/decedent-estate.aspx.