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PLANNING APPROACHES PENDING CLARIFYING LEGISLATION
Paul H. Roskoph
January 2010
The failure of Congress to modify the current tax law regarding estate taxes leaves all clients and advisors in a difficult situation. This relates not only to the planning aspect, but also to the administration of estates since it is unclear what income tax basis will apply for assets of a decedent in 2010 and whether it is necessary to establish a "Bypass Trust." Any decisions made currently will have to be reviewed when legislation is enacted. In the interim, it is equally inappropriate to consciously take no action.
In an effort to provide some degree of clarification of appropriate action, the following steps are to be considered. The following classifications are related only to the estate tax issues; personal planning issues always should be the driving force to any decision.
1. Estates Under $2,000,000. Although the estate tax law calls for exemption of only $1,000,000 effective 2011, a reversion to this lower exemption seems unlikely in the overall scale of the probabilities. If you want to be totally conservative and assume there will be only a $1,000,000 exemption in 2011, it will be important to retain or implement either a "Disclaimer Trust" or mandate the "A/B" Trust. The Disclaimer Trust provides the greater flexibility and would be the probable recommendation for flexible tax planning. Personal planning may suggest the A/B approach to protect the assets of the first spouse to die from redirection by a surviving spouse if this is of concern. My experience is that most first marriage situations are not concerned, and it is likely the surviving spouse will need the funds (and want to control the house).
2. Estates Between $2-$3.500,000. The same general approach seems appropriate as mentioned for estates of less than $2 mm, on the theory that Congress may retain either a $2 mm exemption or a $3.5 mm exemption. In either case, the estate of the surviving spouse would not be subject to tax if a "B" Trust is mandated or implemented through the Disclaimer Trust election. Remember, a Disclaimer Trust provides an option to the surviving spouse to "disclaim" assets from the first spouse by having them pass to a trust for the lifetime benefit of the surviving spouse. Under the current scheme of the federal estate tax law, the disclaimed assets would not be subject to tax in the first estate nor subject to tax in the estate of the surviving spouse, as he or she never had the ownership of the assets that subject them to estate tax.
3. Estates Larger Than $3.5 mm. It would seem that estates in the $3.5 - $4 mm range would continue to follow the same Disclaimer or mandated A/B Trust approach depending upon the circumstances. Flexibility will be the key to try to second guess Congress.
4. Larger Estates. The challenge with the larger estates is not whether to keep the A/B Trust (if you assume there will be an estate tax) but whether more aggressive action should be taken this year before the tax law is changed to take advantage of the current no gift tax situation. This takes a client who is aggressive and willing to take the chance that any law ultimately enacted will not be retroactive. It is my belief this is not likely, but the longer Congress waits to act, the higher the possibility that the legislation will not be retroactive. Remember, however, the last retroactive legislation was in 1979 repealing the generation skipping transfer tax, and that was repealed retroactively three years.
Remember also that gifts transfer the taxpayer's adjusted cost basis to the donee (gift recipient). A substantial gift at the present time may be income tax adverse to retaining those assets as a bequest if the estate tax is reintroduced (as it is scheduled to be in 2011). It is important to note that as the law now stands (2010) there is no estate tax without action of Congress. In addition, because there is no estate tax there is no "step-up in basis" for assets of estates for those who die in 2010. This means that the "carry over" basis rules that apply for gifts now also apply for estates. To provide some relief for this change in the law, Congress has allowed the Executors of the estate (and presumably the Trustees for a Living Trust) to allocate up to $1.3 mm of value to assets of the estate. The selection of those assets is left to this personal representative. This is important since the Executor may or may not be a beneficiary. In addition, the law authorizes the Executor (or Trustee) to allocate an additional $3 mm of basis to assets left to a surviving spouse. Additional information on this topic and how that basis allocation works will be part of a subsequent article.
These initial thoughts are just that. I plan to update this article periodically to provide the latest thinking on this subject and any hints from Congress as to their approach to new legislations.
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