Important Changes in Federal Transfer Tax Law for 2010
January, 2010
Important Changes in Federal Transfer Tax Law for 2010
In 2001 Congress amended the transfer tax provisions of the Internal Revenue Code. As a result, the federal estate tax and the generation-skipping transfer (“GST”) tax would not be applicable to decedents dying in 2010. However, the federal estate tax was scheduled to apply once again in 2011 but at much higher rates and with a lower exemption amount than was applicable in 2009. It had been widely believed in both political and legal circles that this on-again/off-again merry-go-round would be fixed one way or the other before 2010. This has not happened, and the 2001 statutory plan has now gone into effect with an uncertain impact on existing estate plans. While many “experts” feel strongly that there will be retroactive legislation in 2010 reimposing the estate tax and GST tax, there is no guarantee that this will happen. This Advisory discusses some of the issues raised during this period of uncertainty.
Review Existing Estate Planning Documents
The changes in the federal estate tax for 2010 may cause an unintended disposition of property under existing wills and other documents.
Estate planning documents for a married couple often divide the estate of the first spouse to die into two portions. One portion would be equal to the deceased spouse’s unused estate tax exemption amount. The other portion, constituting the balance of the estate, would be left to or in trust for the surviving spouse to qualify for the marital deduction. Under pre-2010 rules, neither portion was subject to estate tax when the first spouse died―the first portion (sometimes called the “credit shelter” or “bypass” portion) escaped federal estate tax because it took advantage of the estate tax exemption and the other portion escaped tax because of the unlimited marital deduction. The credit shelter portion would also escape taxation at the death of the second spouse.
Because of the one-year repeal of the federal estate tax this year (with some states, such as New York, New Jersey, Connecticut and Pennsylvania, retaining independent estate tax systems), it may be uncertain how the provisions of estate planning documents will be interpreted. When provisions in wills and other documents are phrased in terms of tax concepts such as the estate tax exemption amount and marital deduction which, absent retroactive legislation, are not in the law this year, questions may be presented as to the effective disposition of the decedent’s property. Existing wills and other planning documents should be reviewed now.
Another important change that takes effect this year relates to the income tax basis of inherited assets. Income tax basis is the value from which gain or loss on assets sold is measured. Under prior law, the income tax basis of an asset would be changed to its current value when its owner dies, commonly called the “step-up” in basis at death. But this year, this automatic basis adjustment will not occur. Rather, the deceased owner’s income tax basis in assets will “carry-over” to the persons who inherit the assets. The executor of the estate would have the right to allocate up to $1.3 million to increase the basis of assets, as well as the right to allocate a further $3.0 million to increase the basis of assets that pass to a surviving spouse.
GST Tax Considerations
If the GST tax is not applicable to transfers during 2010, certain planning opportunities and traps are presented.
Because there presently is no applicable GST tax, it may be advantageous to make gifts to grandchildren. Although the gift tax would still be applicable, there would be no gift tax due if the donor could use his or her $1 million exclusion (there is a $2 million exclusion if a married couple split gifts). If the GST is restored retroactively to January 1, 2010, there may be a GST tax payable on such a gift. It is possible the GST tax can be avoided in such a scenario if a “defined value clause” can be used effectively. Other techniques may also be available.
It may not be advisable to make a contribution to a life insurance trust for the benefit of a grandchild if the donor’s GST exemption would otherwise be allocated to the contribution. Until it is known when the GST law will be effective again, transfers to life insurance trusts for the benefit of a grandchild could be done by way of a loan, not a gift. Any such loan should be memorialized by the execution of a promissory note signed by the trustee of the insurance trust.
Conversion to Roth IRA
In addition to the traditional IRA, the Internal Revenue Code provides for an IRA known as a “Roth IRA” having certain advantages. In the past, it was difficult for affluent taxpayers to fund Roth IRAs because of income limitations. Beginning in 2010, taxpayers will be permitted to convert a traditional IRA to a Roth IRA on more favorable terms.
Generally, distributions from traditional IRAs are taxable to the recipient, and an IRA owner has to begin taking out distributions after he/she attains age 70-½. In contrast, distributions from a Roth IRA are generally not taxable to the recipient, and there is no requirement for taking out distributions from a Roth IRA at age 70-½.
Prior law prohibited the conversion of a traditional IRA to a Roth IRA if the IRA owner had modified gross income of more than $100,000. Beginning this year, the income limitation is no longer applicable. There will be a toll charge in that the amount in the existing IRA will be treated as a taxable distribution to the IRA owner to the extent that it exceeds any nondeductible contribution previously made to the IRA. However, the law provides that (unless the IRA owner otherwise elects) the distribution is treated as if one-half was made in 2011 and one-half in 2012, resulting in deferral of the income tax liability.
Please contact us if you would like to discuss any of the topics covered by this Advisory.
This Advisory is provided as general information only. No action should be taken solely on the basis of its contents. To ensure compliance with IRS requirements, we inform you that any tax advice contained in this communication was not intended or written to be used and cannot be used for the purpose of avoiding penalties under the Internal Revenue Code or promoting, marketing or recommending to another party any transaction of matter addressed herein.
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This advisory was authored by the firm's Private Clients Group