The Death of the “Death Tax”

4/1/2010

By Andrew Marshall, CPA

In 2001 President George W. Bush signed the Economic Growth Tax Relief Reconciliation Act (EGTRRA), which was designed to phase out the estate tax and generation-skipping transfer tax (GST). This was to be done by gradually increasing the exemption for both taxes from $1 million to $3.5 million from 2002-2009, while decreasing the maximum tax rate from 55% to 45%. EGTRRA stated both of these taxes would be repealed as of January 1, 2010, with a “sunset” provision on the entire bill as of January 1, 2011. This means that there would be no estate or GST tax for 2010, and the bill would revert back to the 2001 tax guidelines as of January 1, 2011. Although Congress did attempt to pass last minute legislation to reverse the 2010 repeal of the taxes, no bill has been finalized.

What does this mean for the 2010 and 2011 tax years? As it currently stands there is no estate or GST tax in effect for 2010, and along with this, the gift tax has been set at $1 million with a 35% tax rate. The basis for inherited assets has also been affected by this law. From 2002-2009 the “step up” basis was used, which means assets are inherited at the current fair market value at the time of the donor’s death. For 2010 the “carry over” basis is to be used, meaning the carrying value of the donor’s original basis. This will result in taxable gains for any increase in the asset from the time of the donor’s purchase through the date of sale. However, an estate can claim a stepped up basis of up to $1.3 million of assets for the 2010 tax year, plus up to $3 million for assets left to a spouse. Due to the sunset provision included in EGTRRA, these taxes will revert back to their 2001 guidelines as of January 1, 2011. These guidelines provide for a $1 million exemption and a maximum tax rate of 55% with an additional 5% tax on estates between $10 and $17.1 million. The transfer of assets will also go back to a step up basis. One question that remains is if Congress will pass legislation that will apply a tax to the 2010 tax year retroactively.

Although some may say a retroactive approach to tax law is unconstitutional, it has not been unheard of in the past. In 1993 the Omnibus Budget Reconciliation Act (OBRA) was passed, and put into effect retroactively. This retroactive application of the Act was challenged by Jerry W. Carlton in 1994, United States v. Carlton, 512 U.S. 26 (1994). The U.S. Supreme Court upheld the constitutionality of the retroactive application of the tax law stating; “(1) the legislation has a rational legislative purpose and is not arbitrary; and (2) the period of retroactivity is not excessive.” A retroactive approach to the estate and GST taxes would almost certainly result in litigation by families who had lost loved ones between now and the passing of any legislation, but it cannot be ruled out of the question.

As it currently stands, the House of Representatives passed the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Act of 2009 (H.R. 4154) on December 3, 2009. This bill would permanently extend the legislation as it stood at the end of 2009, allowing a $3.5 million exemption for individuals ($7 million for married couples) and a tax rate of 45%. With the recent focus on health care reform, this bill has yet to be passed by the Senate, and there is debate as to whether or not it will make it through with the current provisions.

Given the current standstill by Congress on this issue, it may be best to review your will and estate planning to ensure that you have considered all of the possible outcomes for 2010 and going forward. We will keep you updated on any additional actions taken by Congress in our future newsletters.