The Mysteriously Disappearing Federal Estate Tax

From Strauss & Associates, P.A. May 2010 Newsletter:

The old saying goes that nothing in this world is certain but death and taxes — but the disappearing federal estate tax proves the proverb wrong. The future of federal estate tax is all but certain.

Since 1914 the federal government has had some form of estate tax that applied to larger estates when their property passed to beneficiaries. In very basic terms, wealthy families paid significant taxes on the transfer of their fortunes from generation to generation. This reliable source of tax revenue helped to stabilize U.S treasury levels over the years.

Under strange circumstances, the federal estate tax was repealed for the first time in almost a century for the estates of those dying in calendar year 2010. However, some of these estates will still be subject to the estate or inheritance taxes imposed by particular states.

The current situation has its roots in from a 2001 federal law passed by the Republican-controlled Congress and signed by the second President George Bush — the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA). Dubbed the Death Tax by its opponents, the estate tax became subject to a curious 10-year reduction scheme, culminating in its one-year repeal in 2010 and a return to pre-EGTRRA levels in 2011. The unusual 10-year plan was blamed by some on complex congressional rules of procedure and budgeting.

For estate-tax relief, EGTRRA provides this graduated schedule of exemptions along with slowly decreasing tax rates from 50 percent in 2002 to 45 percent in 2009:

• For a death in 2002 through 2003, $1 million of the estate exempt from tax
• For a death in 2004 through 2005, $1.5 million of the estate exempt from tax
• For a death in 2006 through 2008, $2 million of the estate exempt from tax
• For a death in 2009, $3.5 million of the estate exempt from tax
• For a death in 2010, no estate tax

For a death in 2011 or later years, $1 million of the estate exempt from tax and a top tax rate of 55 percent (pre-2002 levels)

As 2010 approached, it was widely assumed by estate planning lawyers that the one-year estate tax lapse would be repealed by Congress and would never happen. Indeed, various proposals were introduced, but in a year dominated by the health care debate, 2010 dawned with the EGTRRA provisions intact and the estate tax unexpectedly lapsed.

A huge problem immediately became apparent. Wealthier people use a variety of complex estate planning tools to minimize the financial impact of the estate tax, such as bypass or marital trusts. While such arrangements make sense within the traditional estate tax structure, these provisions could be interpreted in 2010 when no estate tax is imposed to actually disinherit a surviving husband or wife, clearly contrary to the decedent's wishes.

Such potential problems make it imperative that people consult their estate planning attorneys as soon as possible to inquire whether they should make amendments to their plans, especially people who are ill and anticipate that their possible deaths in 2010 could set into motion legal consequences for the distribution of their estates they did not intend.

In addition, it is a good idea to get sound estate planning advice from a knowledgeable lawyer because it is unclear whether Congress will change the estate tax in some way after 2010. While some feel the repeal should be permanent, many think Congress may instead try to enact a retroactive estate tax for 2010, which would probably be challenged constitutionally. And what might happen after that is anybody's guess. In this uncertain time, get solid legal advice about how to protect your estate, especially if your assets are substantial enough to possibly be subject to a future estate tax.