Predictably Unpredictable; Estate Planning for 2010

& Memorable Quotations

Reprinted from The Estate Analyst, January, 2010

By Robert L. Moshman, Esq.

Caution: The switch to a
carry-over basis is like an
800-pound gorilla
in the room. Watch out!

ontrary to all rational expectations and the predictions of experts, the estate tax has been repealed. There is currently no Federal estate tax.

Has this changed estate planning? Should wills be reviewed, and how should they be modified? What if the estate tax returns, as so many experts continue to expect? How can plans remain flexible enough to cover the many potential scenarios that lie ahead? Let's look at the rules and COLA adjustments for 2010.

Post Estate Tax Planning

Does it really matter that the estate tax was repealed? Some top professionals of estate planning have had a muted reaction to the repeal. Yes, Congress failed to act swiftly to block the repeal, as it may soon do, but so what?

They reason as follows: Even without a Federal estate tax, there are still significant state inheritance and/or estate taxes. Even without a current Federal estate tax, Congress can act at any time to reinstate a tax, so one always has to plan for a tax, whether it exists currently or not. Besides, for 99% of estates, there isn't much danger of Federal estate tax anyway, due to estate size or the unlimited marital deduction.

Even without a Federal estate tax right now, there will be an automatic reversion to the pre-2001 levels in 2011, unless Congress takes action.

So unless someone with an otherwise taxable estate for Federal estate tax purposes is living in a state without death taxes and dies before Congress takes action to reinstate the estate and prior to 2011, a will won't affect the Federal estate tax outcome. However, even in that circumstance, there are critical non-tax reasons for having a valid will in place.

A will names executors, sets up trusts for minors who inherit property, and determines how assets are distributed among beneficiaries.

Also, there is another 800-pound gorilla in the room. In addition to death taxes, estate planning has to contend with capital gains. And this is where things get very interesting. The switch to a carryover basis for assets held at death affects far more people than the Federal estate tax ever affected. Far more decedents own highly appreciated assets.

The 800-Pound Gorilla

Along with the repeal of the federal estate tax came a switch of the treatment of capital gains for property held at death. Capital assets of a decedent held at death have long been provided with a tax basis that is stepped up to the fair market value at the time of death, thus avoiding the difficulty of determining cost basis for assets held for many years, and also avoiding a heavy tax.

How does one feed an 800-pound gorilla? Very carefully. In the case of the carryover basis, there may be many estates with absurd and unfair consequences for which no amount of pre-mortem or postmortem planning would be effective.

It is not fair. The Federal estate tax has long been a graduated tax schedule designed to have the most impact on the wealthiest decedents. In the final year of the phaseout of the Federal estate tax, i.e., for 2009, the estate tax exemption was $3.5 million.

Smaller estates had no Federal estate tax consequences. But now, in 2010, despite the repeal of the estate tax that, at least temporarily, exempts billionaires from estate tax consequences, the arrival of the carryover basis means relatively modest estates will have an unexpected capital gains tax burden.

Mission Impossible

And because every expert and Congress itself had indicated that the estate tax repeal, and the carryover basis that went along with it, were never going to happen, there was no way to plan effectively for this.

Yes, the Federal Tax Code indicated that the carryover basis would arrive in 2010. But it also indicated that the carryover basis would be departing in 2011. And Congress itself said it would prevent the 2010 arrival of the carryover basis. So whom do you want to believe: Congress, Congress, or Congress?

Someone with appreciated assets couldn't just sell their assets in advance of the switch to the carryover basis because that sale would trigger the capital gain during life and cause the premature transfer of an asset. Even now, someone with assets that have appreciated in value cannot have any assurance that the carryover basis will apply at the time of his or her death.

Under the terms of the estate tax repeal, the carryover basis kicked in for 2010 when the estate tax phased out; but under the sunset provisions, when the estate tax automatically reappears in 2011, the stepped up basis returns as well.

Meanwhile, Congress indicates that it will reinstate the Federal estate tax prior to 2011, and it will probably remember to switch the treatment of capital gains for assets held at death back to a stepped-up basis. And it will probably make all of this retroactive. But there are no guarantees of anything. It is about as uncertain as fashion editors predicting turquoise as the color to watch for in 2010.

So it is your classic Congressional tax mess. And taxpayers who ordinarily would not be leaving behind capital gains tax issues now find themselves staring at an 800-pound gorilla in a turquoise leisure suit, and they have no reasonable way to protect their families.

Tax Thresholds for 2009

SOCIAL SECURITY: Gasoline prices peaked at more than $4 per gallon in 2008 and fell to an average of $2.50 per gallon in 2009. With lower energy costs, there was actually negative inflation, also known as deflation. As a result, there is no cost of living increase for Social Security payments neither in 2010 nor in SSI benefits. This is the first time in 35 years without an increase.

SOCIAL SECURITY WAGE BASE: The first $106,800 of income is subject to Social Security tax withholding. This is the same as 2009, which was up from $102,000 in 2008. The FICA rate remains 7.65% for employees and 15.3% for the self-employed.

INCOME TAX BRACKETS: Top individual rates remain at 35% for 2010. For individuals, a 33% rate applies to income over $171,850. The 35% rate kicks in at $373,650 for individuals as well as those married filing jointly. For estates and trusts, the income tax ranges from 15% for amounts under $2,300 and 35% for amounts exceeding $11,120. The standard deduction for single persons is $5,700 and for married filing jointly is $11,400. For expatriation, the threshold limit for 2010 is an average of $145,000 of income tax for the five years prior to loss of citizenship.

AMT KIDDIE TAX: The alternative minimum tax exemption for a child for whom the "kiddie tax" applies under section 1(g) is $6,700.

TOP ESTATE TAX RATE: The top Federal estate tax rate had been 45% for 2009. The tax is repealed for 2010 under the pre-established phase in of the repeal. Congress is likely to reverse these during the year. If Congress fails to act, the estate tax will return in 2011 with a top rate of 55% and an additional 5% surtax for estates exceeding $10 million up to $17,184,000.

ESTATE TAX EXEMPTION: The exemption had reached 3.5 million in 2009 up from the $2-million exemption that applied in 2006 through 2008. No exemption is applicable while the estate tax remains repealed. If the tax is reinstated, a return to the $3.5 million exemption level is a strong possibility. Without action by Congress, an estate tax and a $1-million exemption will return in 2011.

GENERATION-SKIPPING TRANSFER TAX: The fate of the GST tax remains tied to the estate tax. The GST tax is repealed for 2010 but could return in 2011 if Congress fails to act.

GIFT TAX EXCLUSION: The Federal gift tax is NOT repealed. The annual gift tax exclusion remains at $13,000 in 2010. The top gift tax rate drops to 35%, down from 45%. With gift splitting, a married couple can give each beneficiary $26,000 free of the gift tax each year. Increases come in $1,000 increments, based on cumulative inflation adjustments. The next jump, to $14,000, will probably arrive in 2013. Gifts from foreign persons are reportable under section 6039F if they exceed, in the aggregate, $14,165.

GIFT TAX LIFETIME EXEMPTION: The lifetime exemption for gift taxation remained at $1 million, and it will remain at that level through 2011.

SPECIAL-USE VALUATION: The aggregate decrease in value of an estate using §2032A for estate tax purposes is $1 million for 2009.

NONCITIZEN SPOUSES: The exemption under sections 2053 and 2523(I)(2) for gifts to noncitizen spouses increased from $128,000 in 2008 to $133,000 for 2009. The first $134,000 of gifts for 2010 is not reportable.

QUALIFIED FUNERAL TRUST: The limit had been at $9,000 for 2008, up from $8,800 for 2007. But for 2009 and beyond, the limits were repealed as part of the Hubbard Act. So there are no known limits, but a reasonability test may end up evolving.

CAPITAL GAINS: A top rate of 15% continues to apply, and those in low tax brackets pay 0% for 2008 through 2010.

ATTORNEY FEES: For fees incurred in calendar year 2009, the attorney fee award limitation under IRC §7430(c)(1)(B)(iii) remains at $180 per hour.

ELECTIVE DEFERRALS: For 2010, 401(k) and certain other plans will have a contribution ceiling of $16,500 for those 49 or younger and $22,000 for those age 50 or older.

RETIREMENT CONTRIBUTION LIMITS: Limits for SIMPLE accounts remain at $11,500 for 2009, $14,000 for those age 50 or older. Roth IRA eligibility limits for 2010 are $105,000 for full contribution and phasing out up to $120,000 of income for an individual, and from $167,000 phasing out to $177,000 for spouses filing jointly. Regular IRA contribution limits for 2010 are the same as 2009 and 2008, i.e., $5,000 for those 49 and younger and $6,000 for those 50 and older (the "catch up" limit).

COMPENSATION LIMITS: For eligibility in SEPs and other plans remain at $245,000 for 2010.

Sources: For 2010 rates, see IR-2009-45 and Rev. Proc. 2009-50. For 2009 rates, see IR-2008-117 and 118 and Rev. Proc. 2008-66. For 2008 rates, see: Revenue Procedure 2007-66.

MEMORABLE QUOTATIONS

Many well known people departed in 2009. Here is a look back at selected quotes:

Johnny once described our relationship by saying we were as close as two people could be without being married. — Ed McMahon

God wants you well. God wants you prosperous. God wants you a whole person. — Oral Roberts

A healthy male adult bore consumes each year one and a half times his own weight in other people's patience. — John Updike

Is sloppiness in speech caused by ignorance or apathy? I don't know and I don't care. — William Safire, who is also known for writing Spiro T. Agnew's famous quote, "In the United States today, we have more than our share of the nattering nabobs of negativism."

Be true to your teeth, and they won't be false to you. — Soupy Sales

If you live through the initial stage of fame and get past it, and remember that's not who you are. If you live past that, then you have a hope of maybe learning how to spell the word artist. — Patrick Swayze

Now I need to take a piece of wood and make it sound like the railroad track, but I also had to make it beautiful and lovable so that a person playing it would think of it in terms of his mistress, a bartender, his wife, a good psychiatrist- whatever. — Les Paul

Coercion, after all, merely captures man. Freedom captivates him. — Robert McNamara

Investing should be more like watching paint dry or watching grass grow. If you want excitement, take $800 and go to Las Vegas. — Paul Samuelson, economist.

For me, a few hours ago, this campaign came to an end. For all those whose cares have been our concern, the work goes on, the cause endures, the hope still lives, and the dream shall never die. — Edward Kennedy, from his 1980 concession speech after running against Jimmy Carter.

And that's the way it is. — Walter Cronkite

Estate Tax Phaseout 2001 - 2011

+ = In addition to the 55% rate, a 5% surtax applied to certain estates exceeding $10 million.

* = In 2011, item reverts to 2001 level, unless Congress enacts further legislation.

** For carryover basis in 2010 (and beyond if extended by Congress), a limited stepped-up basis would continue to apply to the first $1.3 million of capital gains transferred to a non-spouse and the first $3 million of capital gains transferred to a spouse.

(c) KS 2009.1