As Congress recessed for the holidays, the future of the federal estate tax remained in limbo.  Much controversy exists over the former, present and predicted federal estate tax. Whereas Republicans generally wish to permanently end the estate tax, most Democrats cite the need for tax revenue as the justification for keeping the estate tax that is predicted to generate $26 billion in revenue in 2009. Pursuant to legislation enacted in 2001, the federal estate tax rate was gradually reduced and exemptions were gradually increased until January 1, 2010, when the federal estate tax ceases to exist until 2011, when the federal estate tax is set to reappear with higher rates and a much lower exemption than before. By its failure to act at the end of last year, Congress chose not to change this.

 

In 2009, the highest federal estate tax rate was 45%, and the first $3.5 million of an individual’s estate ($7 million for a married couple) was exempt from taxation.  As of January 1, 2010, the tax rate is 0%.  Then in 2011, the highest rate is set to skyrocket to 55% with only a $1 million dollar exemption.

 

While it appears as though heirs to estates would enjoy a windfall if inheriting in 2010, this is not entirely true, nor is it guaranteed. Previously, assets were accorded an income tax cost basis equal to their fair market value at the time of the decedent’s death. In exchange for elimination of the estate tax, the increase in the cost basis of inherited assets is now limited to $1.3 million or $4.3 million in the case of a spouse.  Also, the federal gift tax continues with the $13,000 annual exclusion and a $1 million exemption, but the highest federal gift tax rate is now 35%.              

 

In response to the Senate’s failure to temporarily maintain the status quo, the Democrat majority promised to quickly enact legislation that would restore the estate tax retroactively to all 2010 estates.  Adding another level of complexity, any retroactive application of an estate tax will ultimately be challenged on constitutional grounds and end up in the judicial system.

 

All of this creates an estate planning dilemma for our clients, especially where the disposition of estate assets is controlled by a formula tied into the then existing federal estate tax exemption, as many are. Charitable dispositions are in jeopardy as well. For questions or concerns regarding the federal estate tax and the resulting impact on your planning, please feel free to contact Thomas M. Turner, David B. Cathcart, Timothy F. Geisse, Meghan B. Kilbane, or Maureen A. Lamb at Mansour, Gavin, Gerlack and Manos Co., L.P.A.