December 21, 2009

As the 2009 legislative session comes to a close, it looks like Congress will not be able to pass an estate tax "patch" by year's end. Estate planning has existed in a state of uncertainty since the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001 (the "2001 Legislation") which provided for a gradual phase out of the tax. The 2001 Legislation provided for an increase in the lifetime exemption amounts from $1 million to its present level of $3.5 million. It also provided for a decrease in the maximum rate from 55 percent to 45 percent. The Republican majority that existed in the House and Senate at the time of the 2001 Legislation did not have the votes to enact a permanent repeal of the estate tax. When the Democrats regained the majority it was expected that the current levels of exemption (or perhaps greater ones) and rate reductions would be made permanent. However, that has not occurred either. It appears that as far as the estate tax is concerned, neither party holds all of the cards.

The absence of a patch makes it particularly difficult for taxpayers to plan. As the law now stands, effective January 1, 2010, estate tax and generation skipping repeal under the 2001 Legislation will go into effect for a one year period. The gift tax, on the other hand, will continue to be in effect subject to the current $1,000,000 exemption and other exemptions such as the annual exclusion and the exclusion for medical and educational expenses. Ironically, since the 2001 Legislation is scheduled to sunset, the estate tax will be reinstated on January 1, 2011, with an estate tax exemption of $1 million and a top marginal tax rate of 55%, the law that was in effect prior to the 2001 Legislation.

The conventional wisdom seems to be that when Congress reconvenes in 2010, it will enact an estate tax "patch" retroactively to the beginning of the year. However, there may be some difficulties with this approach. It is likely that such a retroactive imposition will be subject to a constitutional challenge. It will also present significant political hurdles. The longer it takes, the greater the hurdles and the more unpalatable a retroactive imposition would become.

There thus exists the possibility that actual repeal will stay on the books at least for some period of time. These circumstances present a daunting task for estate planners and their clients. It is unclear whether to react at all to this confusion as to the short term fate of the estate tax law. Some estate planning documents may not work as intended. Whether to redraft estate planning documents in the short term to deal with the technical issues raised by the unexpected reality that repeal will go into effect, at least temporarily, must be carefully considered on a case by case basis.

Another complication is that the corollary of estate tax repeal is the repeal of the unlimited basis step up on death under section 1014 of the Code. This repeal can have a significant impact on many estates. Although a limited basis step up is contemplated ($1.3 million generally, and $3 million for bequests to a spouse), carry over basis for larger estates can be almost impossible to administer. It is unlikely that records will exist in many instances to prove the decedent's cost basis. Moreover, certain leveraged assets such as interests in real estate subject to mortgages, can be subject to phantom income taxation on gains - which tax would have been totally eliminated under the current basis step up on death regime.

Lastly, the situation is further complicated by the fact that the gift tax will remain in effect at its current levels with a $1 million exemption. This will continue to inhibit lifetime transfers which are designed to avoid ultimate estate taxation. The fact that repeal of the estate tax will go into effect temporarily does not obviate estate planning if one believes the tax will return - as it is scheduled to do - even if that occurs in a different incarnation.

We will continue to monitor this rapidly evolving situation. Please feel free to contact us should you have any questions. Our estate planning attorneys are as follows:

Stephen M. Breitstone
Avi Z. Kestenbaum
Joseph Katz
Howard M. Esterces
Lewis S. Meltzer
Michael J. Schaffer
John Proszak
Jeffrey A. Galant
Richard Reichler
Salvatore Bochicchio