May 1, 2010

2010: A Look at the Estate Tax and Wealth Planning


Spring 2010

The 2010 tax year offers little clarity in estate taxation, but with uncertainty come opportunities for lifetime asset transfers. With many of the "Bush tax cuts" set to expire and currently no estate tax, it is unclear what the landscape will look like at the end of the year. But with asset valuations at near historic lows, there are opportunities for transfers of equity in businesses and real property.

Through the end of 2009, tax laws provided individuals with a $3.5 million exemption from federal estate tax. The exemption also applied to the generation-skipping transfer tax, a federal tax on transfers of property made either during life or at death to an individual more than one generation below the decedent, such as a grandchild.

At the end of 2009, individuals were also entitled to a $1 million exemption from the federal gift tax. The top federal estate and gift tax rate was 45 percent. Assets of the estate were "stepped up," meaning that if an individual died owning property that he had purchased for $50,000 and it had a current value of $200,000, the property's value for computing both estate and future capital gains taxes was the value it had at the time of the owner's death.

The estates of individuals who die in 2010 are in a state of flux. It had been widely assumed that Congress would act to extend the provision setting the amount of property exempted from tax, but it has not done so. Currently an estate "may" pass down to heirs free of estate tax and generation-skipping transfer taxes. But the inherited property will no longer have a stepped-up basis. Instead it will have the basis that it had when it was purchased. When the asset is sold, capital gains taxes will be owed on the difference between the cost basis and the sales price.

One complication with the cost-basis method is that the estate will have to account to the IRS. This process involves proving the basis for each asset. Unless the decedent has kept meticulous records, it is unlikely that many estates will be able to provide that type of documentation to the IRS. It is also particularly problematic for assets that have had capital improvements made while they were owned by the decedent. The estate will not only have to find the purchase price but also provide documentation for improvements that were made during the life of the decendent so that that value can be added to the basis. Careful organization and retained receipts by the decedent are both key to this process. Unfortunately, the decedent, the one most likely to have known the assets history, will no longer be around to offer evidence.

Many tax commentators still expect Congress to take action and to create a permanent exemption of approximately $3.5 million. The actual budget proposal includes that provision. It is likely that Congress will try to make the permanent exemption apply retroactively to the 2010 tax year. Some question whether Congress will be able to retroactively enact the tax. Several commentators have opined that the makeup of the current U.S. Supreme Court makes it anything but a sure thing that the retroactive portion of the tax will be upheld despite precedent, which supports retroactivity.

This uncertainty is creating issues for executors who are trying to probate an estate in 2010, since no one is certain what the laws will be at the end of the year and no one knows exactly what documentation is necessary. While the full basis step-up has been eliminated, there remains a 35 percent tax on gifts above $1 million.

If Congress doesn't act, the estate tax and generation-skipping transfer taxes will return on January 1, 2011, but with only a $1 million exemption and a top tax rate of 55 percent for estate and gift taxes.

All of this creates incentives, with risks, for individuals to transfer assets this year, utilizing the federal exemptions that are available for gifts. Over the next several months we will publish a series of articles on the various vehicles for transfers and sales of businesses, and how valuations in today's economy can be used in order to achieve asset transfers free of taxation.

For more information on this topic, please contact or call (888) 598-7070.

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