Way back in 2001 President Bush signed The Economic Growth and Tax Relief Reconciliation Act of 2001 into law. The bill is notable for many things, not the least of which were its estate and gift tax reform provisions, which eliminated the federal estate tax for one year beginning January 1, 2010. Since that time, the general consensus among tax practitioners has always been that Congress would address this and other issues related to the estate and gift tax before December 31, 2009, and come up with a permanent solution. Well - the clock just ran out. Congress did nothing. As of today, there is no federal estate tax, but there is still a Tennessee inheritance tax.

What is different in 2010 under the existing law?

• Both the estate and generation skipping transfer (GST) tax are repealed for 2010, but only for 2010!
• The lifetime federal gift tax exemption remains $1 million, but the top gift tax rate drops to 35%.
• The stepped-up basis rule for assets held at death is repealed and is replaced with a modified carryover basis rule. The recipient of the bequeathed property will receive a basis equal to the lesser of the adjusted basis of the property in the hands of the decedent or the fair market value of the property on the date of the decedent's death. However, executors will be able to increase the basis of estate property by up to $1.3 million with an additional $3 million in the case of property passing to a surviving wife. Thus, an estate will be allowed to increase the basis of property transferred to a surviving wife by as much as $4.3 million.
• Executors of estates will also be required to report certain details relating to transfers at death of non-cash assets in excess of $1.3 million and appreciated property received by the decedent within three years of death for which a gift tax return was required to be filed.

What are the changes for 2011 under the existing law? Effective January 1, 2011, the federal estate, gift and generation skipping transfer tax systems will be reinstated in the same form they existed in 2001. This means that:

• The federal estate tax exemption will be reunified with the lifetime gift exemption at $1 million.
• The top estate and gift tax rates will be 55%.
• The generation skipping transfer tax will come back into play with its $1 million exemption amount and its prior top rate of 55%.
• The stepped-up basis rule will return for inherited assets.

What is going to happen? No one knows for sure.

On December 3, 2009 the House narrowly passed (225 to 200) a bill that extended the 2009 estate, gift and generation skipping transfer tax rules for another year (i.e., $3.5 million estate and GST exemption; $1 million lifetime gift tax exemption). The Senate, however, failed to take up the legislation. Senate Finance Committee Chairman Max Baucus has stated publicly that he plans to move forward with this legislation early in 2010 to ensure that there will not be a period where wealthy taxpayers’ estates will escape the estate tax. We know Baucus believes whatever the Senate passes in 2010 can be imposed retroactively to January 1 because, well, he said so. “We clearly will work to do this retroactively, so that when the law is changed, it will have retroactive application,” said Baucus.

Although many taxpayers will cry, “THEY CAN’T DO THAT!” the retroactive application of tax changes are not that unusual and are typically upheld – especially in the estate and gift tax arena. This is a very unusual set of facts, however, as we aren’t dealing with the retroactive change of a tax rate or an obscure rule, but rather the imposition of what conceptually is a brand new tax. Constitutional scholars are mixed as to whether or not this is permissible.

While no one knows what the end result of all this will be, what is clear is that there will be challenges to any attempted retroactive application of the estate, gift or generation skipping transfer taxes and rates and that these challenges will ultimately be resolved by the Supreme Court. This, of course, makes planning rather difficult.

What is likely to happen?

We know that Congress is controlled by Democrats who generally support the estate, gift and generation skipping transfer taxes with the exemption levels and rates that were in place for 2009. This is the simplest solution by far, and one which appears to be politically viable. But until Congress takes action we remain in uncharted waters. Accordingly, any transactions undertaken in 2010 in reliance on the law currently on the books must be undertaken with caution and must contemplate that the exemptions and rates may be retroactively changed, resulting in additional tax payable. However, as we get further into 2010 and there is some clarification as to direction, there may be planning opportunities that arise. In the meantime, if you have specific situations or concerns you would like to discuss regarding this area, please contact us.

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Lattimore Black Morgan & Cain, PC
615-377-4600
info@lbmc.com