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The Federal Estate Tax - The Saga Continues

Status of the Federal Estate Tax

As of the writing of this newsletter, there is no federal estate tax with respect to persons dying in 2010 – regardless of the size of one’s estate. However, pursuant to a 2001 tax law known as “EGTRRA,” 1 that tax is scheduled to return for persons dying in 2011 and beyond. Under EGTRRA, as of 2011, the federal estate tax law returns to what it would have been prior to the passage of EGTRRA. Thus, the federal estate tax exemption will revert to $1,000,000, and the highest estate tax bracket will be 55%.2

At the end of 2009, it became apparent that Congress would not address the pending turmoil with the federal estate tax law prior to 2010. However, Congress indicated that it intended to implement estate and gift tax legislation in early 2010, which would be retroactive to January 1, 2010. We are now in mid-February, and no such legislation seems to be on the immediate horizon. One legislator apparently expressed the view that as long as a bill is passed by September 30, 2010 (the estate tax return due date for a decedent dying on January 1, 2010), there will be no problem. Of course, this attitude ignores the simple benefit that is derived from knowing the status of the law before one dies, and having the ability to plan with that in mind. If the new estate tax legislation is made retroactive to January 1, 2010, there may be constitutional challenges to such retroactivity. At the present time, no one knows how this situation will be resolved.

The Other Shoe – Income Tax Basis

The 2010 repeal of the federal estate tax is not the complete tax-free ride that it might seem at first glance. For the estate of a decedent dying on or before December 31, 2009, the assets of such decedent received a basis adjustment that caused those assets to have an income tax basis that was equal to the value of the assets for federal estate tax purposes (subject to certain exceptions for assets such as traditional IRA accounts). In many cases, this meant wiping out years of taxable gain for income tax purposes.

However, EGTRRA imposes a “carryover” basis regime – i.e., for a decedent who dies in 2010, the assets of that decedent’s estate will have an income tax basis that is equal to the lesser of the decedent’s basis for the assets or the fair market value of the property at date of death. 3 Thus, one might say that the federal estate tax essentially has been converted into a capital gains tax.

There are two major exceptions to the carryover basis regime. First, $1,300,000 of the appreciation in a decedent’s assets may receive a step-up in basis, regardless of the beneficiary of those assets. Additionally, assets passing to a spouse in certain qualified ways may receive an additional step-up in basis of $3,000,000 of appreciation. Please note that the $1,300,000 and $3,000,000 amounts apply to the appreciation in a decedent’s assets, and not to the value of the assets themselves.

Maryland, My Maryland

Even though there may not be a federal estate tax for decedents who die during 2010, Maryland imposes an estate tax on estates over $1,000,000.4 Although Maryland law limits its estate tax exemption to $1,000,000, for married couples it allows one to defer (not avoid) the Maryland estate tax on the excess over the federal exemption until the second death, as long as the differential between the federal and Maryland exemptions is held by a trust exclusively for the surviving spouse’s benefit.

“What do I do??!!??”

We suggest that you contact us to see if your estate planning wishes are carried out by your current planning documents, taking into account the current state (or disarray) of the estate tax law. The existing repeal may have a significant impact on your plans. For example: (1) if your Will leaves your estate tax exemption amount to your children, and the balance of your estate to your spouse, you may be unintentionally disinheriting your spouse, or (2) if your Will leaves your generation-skipping transfer tax exemption amount to your grandchildren, and the balance of your estate to your children, you may be unintentionally disinheriting your children. Notwithstanding the foregoing, there may be certain planning advantages under the existing law.

Maryland is considering an emergency bill that would apply the 2009 federal estate tax law to the distribution of your estate, unless you state otherwise. However, even if this legislative “patch” is enacted, it may be wise to at least make certain modifications to your planning documents pending further clarity from Congress.

If you have any questions about these matters, please contact your regular Gordon Feinblatt attorney, or our Trusts & Estates Law Practice Group:

Laura L. Johnson, 410-576-4065

Marc P. Blum, 410-576-4240

Mary Rose Cook, 410-576-4215
1 EGTRRA included an increasing exemption from the federal estate tax from 2002 through 2009, culminating in a repeal of the estate tax in and for 2010 only. In 2009, the federal estate tax exemption amount was $3,500,000 (to the extent it was not consumed during the course of one's life to offset gift taxes), and the highest estate tax bracket was 45%.

2 The imposition of the generation-skipping transfer tax has been similarly affected, but when that tax returns in 2011, its $1,000,000 exemption will be inflation adjusted. While the highest gift tax bracket has been reduced to 35%, taxable gifts made in 2010 are still subject to a federal gift tax, subject to a $1,000,000 exemption ($2,000,000 for spouses electing to make split gifts).

3 The carryover basis regime applies only to estates of decedents dying in 2010; for decedents dying in 2011 and later, the date of death basis adjustment rules will apply once again.

4 This was even true for persons dying in 2009, when the federal estate tax exemption amount was $3,500,000. It is also important to note that although a federal estate tax return may not be required for federal purposes, Maryland law forces a decedent’s estate to incur the cost of having a pro forma federal return prepared as an attachment to the decedent’s Maryland Estate Tax Return.