With no federal estate tax in 2010, do I really need an estate plan?

The short answer is “YES!” Even though the federal estate tax has been repealed, at least for a year, there are still countless other issues that need to be addressed by a proper estate plan. Naming a guardian for minor children or children with special needs, protecting assets from creditors, providing for the payment of certain expenses, providing for future generations, insuring children from a previous marriage are protected and provided for, are just a few of these reasons. Additionally, while the estate tax is down, it is not out. The estate tax is scheduled to return in 2011 with a lower exemption amount and a higher tax rate.

A recent article published by the New York Times highlights some of the concerns caused by the ever-moving target that is the estate tax regime. Here are some of the highlights as well as my commentary on the issue.

As many are aware, the federal estate tax is taking a one-year hiatus in 2010. While many predicted that the U.S. Congress would act to avoid this, it did not. Thus, for one-year, there is no federal estate tax, at least for now. In 2011, however, the federal estate tax comes back, and this time, the federal estate tax reverts back to the smaller $1 million estate tax exemption amount and the higher 55% marginal tax rate. While there are countless jokes about encouraging rich relatives to take advantage of this, this advice, while in jest, my be completely wrong.

First, under the old federal estate tax regime, an heir took the property at its current fair market value (i.e., got a step-up in basis). For instance, let’s say “mom” purchased a house in for $15,000 and under her will it goes to her son. If at the date of her death the house is worth $200,000, son would of had a $200,000 tax-basis in the house. Thus, if he decided to sell it the next day, he would have had no taxable gain on the house ($200,000 – $200,000). In 2010, however, there is no step-up in basis. Instead, son not only inherits the house but also mom’s basis in the house. So, if mom dies in 2010 and son sells the house, son would have to recognize a $185,000 capital gain ($200,000 - $15,000). Even at the current capital gain tax rates, this could be a significant tax. Congress has authorized a $1.3 million capital gain exclusion to curb some of this, but with the exploding real estate values over the last few decades and the similar appreciation of stocks, this $1.3 million exclusion might be quickly exhausted.

And this doesn’t even get into trying to calculate the deceased’s basis. Many individuals have held real estate and stocks for many years, sometimes even decades. How are the heirs suppose to recreate a transaction that may have occurred even before they were born? And who pays the administrative and legal fees of doing this? Additionally, the use of real estate may affect the deceased’s basis. Certain expenses and fees paid in relation to a person’s primary residence increase basis. So for real estate, one would have to go back to each year the property was owned and determine what expenses occurred in that year, what they were for, and how the real estate was being used in that year in order to determine the appropriate tax basis at the date of death.

Another issue is that sound tax planning advice in 2009 may now only work to frustrate a person’s true intent. Many estate planning attorneys advocate maximizing both spouses estate tax exemption. A simple way to do this is to draft a will that passes a portion of a person’s estate as to make it estate tax taxable. The will limits this amount, however, to whatever amount may be passed tax-free under the federal estate tax law. The attorney and the testator intend for this amount to equal the then current estate tax exemption. This provision usually works to pass the taxable portion of the estate to heirs other than the surviving spouse with the remainder of the estate going to the surviving spouse. Now with the nothing being subject to a federal estate tax, the testator’s property would pass in such a way as to exclude the surviving spouse. Thus, the surviving spouse would not be provided for. Short of utilizing a complex disclaimer regime or having the spouse take under the state’s elective share or dowry laws, the spouse may be left with nothing. And this only gets more complicated when there are children of a previous marriage who are unwilling to consent to any proposed division.

Finally, there are rumblings that the U.S. Congress may enact estate tax legislation that would retroactively apply to January 1, 2010. The legality of this is questionable. But if it happens, the estate planning documents you draft today may be obsolete tomorrow. How do you plan for something that may or may not exist, where the rules are undefined, and legal battles are sure to ensue?

Visiting an experienced Kansas or Missouri estate planning attorney is a must. And here are just a few of the thoughts and questions you should consider when talking with your estate planning attorney:

1. Regardless of the tax law, where do I want my property to go?
2. Are there any individuals that will need special care after I’m gone, and should I set up a trust to do this?
3. Who should be the guardian of my minor children? Children with special needs?
4. Who should manage any trusts I establish?
5. Do any of my potential heirs have creditor issues?
6. Does my spouse have sufficient assets to provide for herself after I’m gone?
7. Can I prove my tax-basis in my assets?
8. If the estate tax law changes tomorrow, how will my property pass? (An experienced estate planning attorney who is current on the recent estate law developments should be able to show how different assumptions affect your plan.)

– ksmolawyer

Related posts:

1. Three proposed changes that could significantly affect your estate plan.
2. An effective and experienced estate planning attorney can prove invaluable in protecting your dependents.
3. 2010 MO HealthNet Figures
4. Paying too much in property taxes? Now is the time to file an appeal.
5. Tenancy by the entireties and Missouri bankruptcy exemptions.