Federal Estate Tax Repeal -- It Really Happened!

From the moment in June 2001 that President Bush signed into law the legislation that provided for the repeal of the Federal estate tax in 2010, “experts” have been convinced that Congress would by now have acted to “fix” what is widely acknowledged to be preposterous tax policy. Not only does the repeal exist for this year only, but the Federal estate will return with a vengeance in 2011, as the exemption returns to its 2000 level of $1,000,000 per person. Compared with the 2009 exemption of $3,500,000, 2011 will see many more “middle class” estates subject to the imposition of federal estate tax.

But just because there’s no federal estate tax in 2010 doesn’t mean that Congress has necessarily done taxpayers a huge favor. That’s because 2010 also brings the elimination of the unlimited “step-up” in basis for inherited assets. In 2010, only the first 1.3 million assets ($4.3 million if there’s a surviving spouse) will be valued at their “date of death” value for capital gains purposes. All other assets will be passed to the heirs at a “carryover” tax basis, and will result in the imposition of a capital gains tax if appreciated assets are later sold by the heirs. Trying to determine the original tax basis of many assets – especially stocks that may have been owned by a decedent for many years – will be a record-keeping nightmare.

We’re already seeing the impact of this irrational tax policy. A recent article in the New York Post described how 87 year-old Fritz Lohman died at 11:00 a.m. on New Years’ Eve. Since Lohman died in 2009, his $10 million estate will be subject to a total estate tax in excess of $3,500,000. Had Lohman survived thirteen hours, his estate would have been subject to a New York estate tax of about $1,000,000.

Why this tax roller coaster? When estate tax repeal was passed in 2001, the Senate’s budget rules required that the legislation had to “sunset” in 2011. The Republicans were then able to claim that they had lived up to their 2000 election promise to repeal the estate tax, leaving it to future Congresses and Presidential administrations to come up with a more permanent resolution. The Republicans came close to passing a permanent repeal of the estate tax during the latter years of the Bush administration, but fell a few votes short. Now, with the nation fighting wars on multiple fronts, with the need to fund health care on the horizon, and with the country’s economy stagnant, it seems unlikely that Congress will be willing to forego the revenue that would be generated by the estate tax beginning next year. At best, we may see legislation enacted that will return the tax to the 2009 per person exemption of $3,500,000.

What’s the average person to do? Married couples with total assets (including the value of the death benefit of life insurance) in excess of $2 million need to review their wills or living trusts to ensure that the estate tax planning language takes into account the possibility of a death in a year without a Federal estate tax. The absence of such a “savings clause” might result in unforeseen consequences that might be contrary to your intent.

Using a Trust for Disability Planning

People often think of estate planning only in the context of “death planning.” However, failing to account for the possibility that someday you may need help managing your personal and financial affairs might prove to be a huge mistake. If no one is vested with legal authority to handle your affairs in the event of your incapacity, your loved one’s might be forced to file a petition for Guardianship in Supreme or Surrogate’s Court. Guardianships are time consuming, expensive, and cumbersome, as court-appointed Guardians are required to file annual accountings with the court.

One of the major advantages of a Living Trust as compared with a Will is that a Will is effective only upon the Testator’s death, and thus is of no value if the Testator becomes disabled during his or her lifetime. In contrast, a Living Trust is a contractual agreement that becomes effective as soon as it is executed. The Trust will typically provide that one or more successor Trustees are authorized and directed to administer the Trustmaker’s financial and personal affairs in the event of the Trustmaker’s disability. Note that the successor Trustees have control over only those assets actually owned by the Living Trust, highlighting the importance of transferring the Trustmaker’s assets to the Trust during his or her lifetime.

An important consideration in a Living Trust design is the mechanism for determining when the Trustmaker is in fact disabled. Many “boilerplate” trust documents provide that the Trustmaker is deemed disabled when a doctor, or maybe two doctors, make such a determination. Given the option, however, many people prefer having their spouse, adult children, or other loved-ones participate in such a critical determination. A Living Trust can include a “disability panel” comprised of one or more medical professionals as well as a combination of family members or friends. The disability panel may be given authority to make a determination of the Trustmaker’s disability by unanimous vote, by a majority, or any other method as determined by the Trustmaker.

Once the disability panel has made a determination that the Trustmaker is disabled, the successor Trustees will be authorized by the terms of the Trust to take control of the Trustmaker’s personal and financial affairs. Many Trusts will provide that the successor Trustees are to simply provide for the Trustmaker’s “general welfare,” or words of a similar nature. Such an open-ended approach gives the successor trustees little guidance, and gives little insight into the Trustmaker’s true feelings. Also, such generic language gives the successor Trustees no authority to use trust assets to provide for the well-being of the Trustmaker’s spouse, children or other beneficiaries.

Well-designed Living Trusts will provide the successor Trustees with detailed disability instructions that are customized to meet the Trustmaker’s goals and objectives. Such provisions might include the Trustmaker’s preference for living arrangements, their favorite hobbies and activities, preference for religious or spiritual practices, instructions regarding the care of pets, and a description of other beneficiaries whom the Trustees are authorized to provide for out of the trust assets.