Charting a Course: Estate Planning 2009–2011

This special report is published as a supplement to the July 2009 issue of The Tax Adviser. It looks at the status of estate, gift, and generation-skipping transfer taxes over the next few years.1


Current State of the Law

In 2001, Congress enacted the Economic Growth and Tax Relief Reconciliation Act (EGTRRA).2 This law was designed to result in the slow repeal of the estate and generation-skipping transfer (GST) taxes. Under the EGTRRA provisions, the estate and GST tax rates have gradually declined over the past nine years (see the exhibit) so that the highest rate is 45% this year, and there will be no tax in 2010. Similarly, the exemption amount has gradually increased, reaching $3.5 million in 2009. EGTRRA also phased out the state death tax credit over a four-year period, and in 2005 the credit became a deduction.3


Under the drafters’ original plan, the estate and GST taxes would have been permanently repealed after 2009. However, the forecast cost of permanent repeal was politically unpalatable in 2001, so at the last minute the congressional conference committee added a sunset provision to EGTRRA to keep the costs of the bill small enough to ensure widespread support in Congress. Under the sunset provision, the repeal will be in effect for one year only: 2010. After that, the estate and GST regime in place before the passage of EGTRRA will spring back to life, as if EGTRRA had never been enacted.4 This means that in 2011 the exemption will be reduced to $1 million (adjusted for inflation), the tax rate will be 55%, and the state death tax credit will be revived.


In 2001, it was widely assumed that Congress would not allow this sunset of the EGTRRA provisions to occur and that the estate tax repeal would be made permanent before 2010. However, while the sunset has been removed from a few EGTRRA provisions,5 Congress has not managed to do anything to make the repeal permanent or to change the exemption amounts or tax rates after 2010.


Carryover Basis

EGTRRA also repealed the step-up in basis for assets passing at death. Instead, inherited assets will be subject to a modified carryover basis rule starting in 2010. Under this new rule, a recipient’s basis in property acquired from a decedent will be the lesser of the adjusted basis of the property at death or the fair market value (FMV) on the date of death.6 The heirs will recognize any appreciation in the property when they sell the property. Each estate will be permitted to increase the basis of assets owned by the decedent and transferred at death by an additional $1.3 million. Assets left to a spouse may receive an additional $3 million basis increase.7


As things stand now, the carryover basis provision is scheduled to sunset after 2010. This leads to a situation in which assets inherited in December 2009 or January 2011 will have a basis that is stepped up to FMV; assets inherited in 2010 will have a carryover basis.


Gift Tax

EGTRRA did not repeal the gift tax along with the estate and GST taxes. Instead, in 2004, the gift tax exemption was decoupled from the estate tax exemption and has remained at $1 million. After the estate and GST taxes are repealed in 2010, the gift tax rate will be reduced from 45% to the maximum individual income tax rate (currently 35%).8 Then it too will revert to its pre-EGTRRA levels in 2011. The gift tax exemption was apparently limited to $1 million during the phaseout period out of concern that a higher exemption would allow taxpayers to make tax-free gifts of low-basis or income-producing assets to taxpayers in lower brackets, thus eroding the income tax base.9



EGTRRA also repealed a GST trap for the unwary. Before EGTRRA, each transferor had a $1 million GST exemption that he or she could allocate to lifetime gifts or transfers at death. Under the rules at the time, the exemption would automatically be applied to direct transfers (outright gifts). However, transferors had to elect to have the exemption apply to transfers to trusts. This caused problems when transferors (and their tax advisers) inadvertently failed to make the election. EGTRRA extended the automatic exemption allocation to GST trusts (and also increased the GST exemption).10 (See Exhibit: Estate, gift and GST changes, 2001-2011)


Problems in the Near Term

The major uncertainty affecting estate planning over the next few years is: What happens after 2010? As things stand now, estates face an almost unthinkable prospect: The largest exemption and lowest rates this year; no estate tax next year; then a small exemption and higher rates in 2011. Adding to the planning difficulty is the fact that almost no one anticipates that things will actually play out this way.


Almost since the passage of the 2001 act, there has been a widespread assumption among commentators that Congress would not permanently repeal the estate tax but would continue it in some form with low rates and a high exemption. However, although various bills introduced over the past 10 years would have either continued the estate tax in some form or made repeal permanent, none has been enacted. Commentators still anticipate that some legislation will be enacted before 2010 (or at least before 2011), but the exact contours of that legislation are hard to predict. In his budget proposal for fiscal year 2010, President Obama has proposed keeping the estate tax situation in its 2009 state. The proposal does not contain many details, but presumably this would mean a 45% estate tax rate and a $3.5 million exemption. (It does not specifically mention the GST tax.)


What Would Sunset Mean?

The exemption amount of $3.5 million lasts only through 2009; in 2010 there is no exemption (because there is no tax); then in 2011 the exemption reverts to $1 million. Meanwhile the tax rate goes from 45% this year to 0% in 2010 and to 55% in 2011. In addition, the GST trap will return: the automatic exemption allocation is scheduled to sunset after 2010.


Carryover Basis Issues

Estates will face a number of basis valuation issues next year with the change to carryover basis, even more than they do under the current step-up in basis system. Discovering (and proving) the decedent’s basis in an asset could be difficult or impossible. Elderly decedents will be bequeathing assets that they may have acquired 50 or more years ago. Receipts or other sales records from their acquisition of the property may be nonexistent. The decedent may have inherited the asset many years ago, with no record of the basis. Gathering evidence to prove what the FMV of an asset was many years ago may not be possible. Then (as the law stands today), after a year of attempting to prove carryover bases, the step-up basis system will return.


The change to a carryover basis regime may affect more taxpayers than any other aspect of the estate tax repeal. Under the current estate tax, many heirs can sell inherited assets with little or no capital gains tax due because they took a stepped-up basis when they inherited the assets. Under a carryover basis system, the heir will have to pay tax on the entire accumulated increase in the asset’s value. For assets acquired in the distant past, almost the entire sales price may represent gain, but even for more recently acquired assets, the carryover basis system represents a tax increase to the heirs because the decedent’s gain is no longer recognized tax free by them.


State Inheritance Taxes

Another problem facing estates today is that states are scrambling to make up revenue with the demise of the federal state death tax credit. To avoid diminishing tax revenues, many states have decoupled from the federal estate tax (because it is going away) and enacted their own estate or inheritance tax regimes. In the past, estates received a state death tax credit, allowing states to easily piggyback their inheritance tax onto the federal estate tax, which meant that heirs had no additional tax burden from the state.


Now many states no longer piggyback, so whatever estates are saving in federal estate tax they may be more than losing in state inheritance tax. If the federal estate tax were to be permanently repealed, this trend would continue.


Decoupling of Estate and Gift Tax

Professor Roby Sawyers, testifying on behalf of the AICPA before the Senate Finance Committee in April 2008, discussed issues raised by the decoupling of the estate and gift tax exemptions. Decoupling causes planning problems: Under prior law, taxpayers could use the unified estate and gift tax exemption to offset both bequests and lifetime gifts. This made planning for whether to gift assets during life or bequeath them at death easier because there were fewer variables to consider.


Decoupling also discourages taxpayers from making lifetime gifts of property or engaging in business succession planning. Historically, the gift tax has been less expensive than the estate tax, giving taxpayers an incentive to make lifetime gifts and distribute family capital to younger generations. (It thereby also potentially accelerates tax revenue.) Small business owners were encouraged to plan for the orderly transfer of management and control of their business during their lifetimes. Older taxpayers were encouraged to make lifetime gifts to their descendants.


AICPA Recommendations

The AICPA has urged Congress to make a number of reforms in order to solve some of the problems with the current system. The AICPA sent the following recommendations to the Senate Finance Committee on March 11, 2008:

  1. Make permanent the EGTRRA technical modifications to the GST tax rules that eliminated the prior-law traps.
  2. Increase the exemption amount to eliminate filing and tax burdens for 90–95% of estates and index the exemption amount for inflation.
  3. Retain the full step-up in basis to FMV for inherited assets to avoid the complexities of carryover basis.
  4. Create a uniform exemption amount for estate, gift, and GST tax purposes in order to simplify tax planning.
  5. Reinstate the full state death tax credit or provide another mechanism for the state to piggyback onto the federal estate tax.
  6. Provide broad-based liquidity relief rather than targeted relief provisions.
  7. Make the top estate tax rate no higher than the top individual tax rate.

What Lies Ahead?

In his budget proposal for fiscal year 2010, President Obama has proposed keeping the estate and GST tax rules in their 2009 state. Both houses of Congress passed the proposal on April 30, 2009. Whether the actual budget as eventually passed will contain the items in the proposal remains to be seen.


The budget proposal anticipates a $72 billion decrease in government revenue for fiscal years 2010–2014 and a $256 billion decrease in government revenue for fiscal years 2010–2019 if the estate and gift tax rules for 2009 are extended into the future. The budget proposal language says that continuing the 2009 estate and gift tax situation would mean that “only a minute fraction of estates” would owe tax.11


Other bills have been introduced in case the 2010 budget does not end up containing estate and gift tax relief. For example, on March 26, Sen. Max Baucus (D-MT) introduced the Taxpayer Certainty and Relief Act of 2009, S. 722, which would make the estate tax permanent at a 45% top rate and would reunify it with the gift tax by restoring the unified credit at $3.5 million. It would also provide portability of the exemption between spouses. This bill has been referred to the Senate Finance Committee. Its fate is unknown at this time.


The president has also proposed other changes that would affect estate planning. In order to raise revenue for health care reform, he is proposing to institute a minimum term of 10 years on grantor retained annuity trusts. Another proposal would curb the amount of discount available in valuing an interest in a familycontrolled entity transferred to a member of the family if, after the transfer, the restriction will lapse or the transferor and/or the transferor’s family may remove the restriction.12


Estate Planning for 2009 and 2010

With the estate tax uncertain and changing over the next three years, taxpayers should try to avoid the estate tax regime altogether by making tax-free transfers out of their estates.


Lifetime Gifts

Taxpayers are allowed an annual exclusion from the gift tax for gifts of up to $10,000 (adjusted for inflation since 1997) per donee to an unlimited number of donees. The inflation-adjusted amount for 2009 is $13,000. Spouses can combine their exclusion amounts, allowing a married couple in 2009 to give gifts of up to $26,000 per donee tax free. Gifts in excess of the annual exclusion amount may also be offset by a taxpayer’s lifetime gift tax exemption (currently $1 million). In addition, payments of qualified tuition and health care expenses are not subject to gift tax under Sec. 2503(e).


Transfers Between Spouses

Property can be transferred tax free from one spouse to the other spouse who is a U.S. citizen, whether the transfer is made outright or in trust, during lifetime or upon death.13 Transfers in trust to a spouse are tax free only if the trust, at a minimum, distributes all income to the spouse for life.14 There can be no limitation on this requirement. Thus, for example, a trust that provides distributions of income to a spouse until that spouse remarries or until a house is sold will not qualify.


Trusts can qualify for the tax-free transfer between spouses, even if the surviving spouse receives a life estate, if the executor elects to designate the property as a qualified terminable interest property (QTIP) trust. A QTIP trust defers estate tax for an unlimited amount of property (the assets in the QTIP trust will be includible in the surviving spouse’s gross estate and potentially subject to estate tax). A QTIP trust also ensures that upon the death of the surviving spouse, the remaining property will pass to the beneficiaries designated by the first-deceased spouse. Finally, the QTIP trust can provide a measure of asset protection for the surviving spouse because assets in a QTIP trust are not generally recoverable by the surviving spouse’s creditors.


Also see Exhibit: Estate, gift and GST changes, 2001-2011


1 Readers with specific estate-planning questions should consult a professional tax adviser.


2 Economic Growth and Tax Relief Reconciliation Act of 2001, P.L. 107-16.


3 Secs. 2011(f) and 2058(a).


4 See EGTRRA §901.


5 See, e.g., Sec. 102(c) (relating to the election to include combat pay as earned income for purposes of the earned income tax credit); EGTRRA §901(c) (relating to restitution payment for Holocaust victims); and the Pension Protection Act of 2006, P.L. 109-280, §811 (relating to pension and IRA provisions of EGTRRA). None of the provisions made permanent is related to estate, gift, or GST taxes.


6 Sec. 1022(a), as added by EGTRRA §542(a); Sec. 1014(f), as amended by EGTRRA §541.


7 Sec. 1022(c).

8 Sec. 2502(a)(1), as amended by EGTRRA §521(b).

9 American Bar Association, Report on Reform of Federal Wealth Transfer Taxes, Part 2 (2004).

10 Sec. 2632.


11 Conference Report, Legislative Language of S. Con. Res. 13, FY 2010 Budget Resolution.


12 Dept. of Treasury, General Explanation of the Administration’s Fiscal Year 2010 Revenue Proposals (May 2009).


13 Sec. 1041(a).


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