Repeal of the Federal Estate and Generation-Skipping Transfer Taxes May Have Unintended Consequences on Individual Estate Plans
January 29, 2010
After nearly a decade of debate and fitful attempts to reach bipartisan tax reform, the federal estate and generation-skipping transfer taxes were temporarily repealed on January 1, 2010. The federal gift tax remains in effect with a temporarily reduced rate. The repeal of the federal estate and generation-skipping transfer taxes may have an unforeseen impact on your estate planning documents and increase your exposure to state level estate taxes or cause your estate to be distributed in a manner that is not consistent with your intentions. Therefore, it is critical that you review your estate planning documents in light of the new law.
The ever-shifting tax landscape with which we are confronted is the result of the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). EGTRRA gradually increased the federal estate tax exemption amount and lowered estate tax rates through 2009. Moreover, on January 1, 2010, EGTRRA:
- Repealed the federal estate tax for one year.
- Repealed the federal generation-skipping transfer tax for one year.
- Retained the federal gift tax and the $1 million exemption from gift taxes and reduced the gift tax rate from 45% to 35%.
- Made dramatic changes to the income tax treatment of assets that are inherited in 2010. Under previous law, the income tax basis of an asset was adjusted to its fair market value when its owner died. But, for deaths occurring in 2010, there will only be a partial basis adjustment available, potentially saddling family members with substantial and unforeseen income tax liabilities.
These changes will only be in effect for 2010 and the tax laws will then be reinstated as they existed in 2001. Therefore, barring Congressional action, on January 1, 2011, the federal estate and generation-skipping transfer taxes will be reinstated with substantially higher rates and reduced exemptions, gift tax rates will be increased, and assets will once again be inherited with an adjusted, rather than carried over, basis.
It Is Critical That You Review Your Estate Planning Documents
Although the temporary repeal of the federal estate and generation-skipping transfer taxes may provide some taxpayers with a benefit, it may also cause unintended consequences in many individuals’ estate planning documents. This is because many estate planning documents were drafted with tax planning goals in mind and make reference to tax concepts that are not effective in 2010. For example, a taxpayer’s will may fund a trust for the benefit of his or her children with the maximum amount that can pass tax free for federal estate tax purposes and pass the remainder of the estate to his or her surviving spouse. Under the new law, this common allocation of assets might cause unintended consequences by funding the children’s trust with the entire estate (because the entire estate can pass free of federal estate taxes in 2010) and thereby unnecessarily trigger Minnesota estate taxes and inadvertently disinherit the surviving spouse.
Given the fluid state of current tax law and the unforeseen consequences the law may have on you, it is imperative that you review your estate planning documents to ensure that your assets will be distributed consistent with your wishes and in a tax efficient manner. If you would like assistance reviewing your estate planning documents, the estate planning lawyers at Fredrikson & Byron are on hand to consult with you.