In 2001 the Economic Growth and Tax Relief Reconciliation Act (“EGTRA”) was passed which among other things repealed the Federal Estate Tax. But because of budget limitations, the repeal is for only one year, the year 2010. January 1, 2011, the estate tax comes back automatically unless the law is again changed by Congress.
At the same time is made a change in the law pertaining to capital gains taxes to reflect this repeal. When the estate tax was repealed, the law was changed to provide that when someone inherited an asset, and later sold it, they would henceforth have to calculate their gain by subtracting their benefactor’s cost from the proceeds of the sale. But unlike the repeal of the Estate Tax which is only for one year, this change is permanent.
So come January 1, 2011, unless Congress changes the law, we will have a return of the Estate Tax but the capital gain calculation will remain using the benefactor’s cost to calculate the gain. Thus, when someone dies, their estate might be subject to an Estate Tax, and when those assets are sold by the heirs, those same assets might be subject to a capital gains tax on the same value which was subjected already to the Estate Tax.
It is much more detailed and complicated than described above, but let’s keep it simple for now.
Most people expected that Congress would do something to correct this situation. They thought it would be corrected by Congress passing legislation in 2009 which would continue the Estate Tax and reverse the capital gains tax changes, thus leaving everything as it was on 12/31/2009. But that didn’t happen. And now it seems no one in Washington is willing to compromise.
Even if Congress does agree on something, will it be retroactive to 1/1/2010? Can it legally be retroactive to 1/1/2010? The answer is that no one knows for sure. There are two U.S. Supreme Court cases addressing the issue of retroactive tax legislation, one holding that it can be retroactive and the other holding exactly the opposite. So if the tax legislation is made retroactive to 1/1/2010, litigation is likely to follow perhaps taking years to reach the U.S. Supreme Court for a final ruling.
So several major questions arise, two of which are:
1) What do we do with estates of persons who have died during 2010 before any legislation passes?
2) How do we prepare estate plans for clients now, not knowing what the Estate Tax law will be even next year?
The answer to the first one is to put off doing everything you can as long as possible with the hope that the smoke will clear and we can then follow the path provided without having wasted a lot of time and money going down the wrong path.
Do we take the same approach to preparing estate plans; hold off doing any estate planning until the smoke clears? That is impractical. Doing nothing will result in people passing away with no estate plan, and that would be the worst of all results. So estate plans still need to be prepared, but how? Do we plan on a $1,000,000 Estate Tax exemption returning January 1, 2011, or plan on the repeal (retroactive or otherwise) of the Estate Tax repeal, reinstating 2009 exemption levels? I suggest that you can’t take either of these courses without hedging your bet because if you don’t hedge your bet, you might be wrong resulting in a huge loss. So how do you hedge your bet?
The American Academy of Estate Planning Attorneys (“AAEPA”) nicely addressed this issue eight years ago by the inclusion of special provisions in trust documents which permit the successor trustee to appoint a special co-trustee (probably the estate planning attorney) who has the authority to change the estate plan if necessary to minimize the damage and maximize the benefit resulting of any changes in the Estate Tax law and related capital gains tax law. This way, no matter which way you place your bet, after the dice has been rolled, the plan can be changed so the client’s heirs are winners.
I always explain to people that one of the advantages of our using the AAEPA documents is that they are extremely comprehensive, including contingency provisions not normally occurring in estate planning documents. As a consequence, our clients who have had their estate plans created after 2001 have estate plans which contain these special provisions and need not worry about what changes will or will not be made to the Estate Tax because the document gives the authority to correct the estate plan to reflect the results of the roll of the dice. At the same time, many members of the estate planning community are advising their clients that they need to pay to have interim amendments prepared to prevent them from being caught short.
So what are we doing for our clients? We are creating plans based upon the client’s view of the future knowing that even if they’re wrong, the plan can be corrected, even after death and the dice have already been rolled.