For Now, Estate Tax Is Up in the Air

(RIVERWOODS, ILL., January 2010) – For the first few weeks of 2010, at least, executors of the estates of people dying after December 31, 2009 will be operating in a difficult environment, according to CCH, a Wolters Kluwer business and a leading provider of tax, accounting and audit information, software and services (CCHGroup.com).

Under the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the maximum estate tax rate dropped steadily from 55 percent in 2001 to 45 percent in 2009. In addition, during that same period, the amount of property excluded from the estate tax has risen from $675,000 to $3.5 million in 2009. But EGTRRA called for a full repeal of estate taxes in 2010 before jumping back to the pre-EGTRRA rate of at least 55 percent in 2011, plus a 5-percent surcharge on large estates, with an exclusion amount of $1 million.

“For several years, most people assumed that some sort of ‘fix’ to the estate tax that would avoid outright repeal but would also restrict the tax to relatively large estates would be enacted by the end of 2009,” said CCH Senior Estate Tax Analyst, Bruno Graziano, JD, MSA.

But while such a bill passed in the House, the Senate failed to extend the estate tax before the end of the year because Democrats were divided over the terms of an extension and most Republicans opposed the tax.

This has led to the following major changes in the transfer tax regime, at least temporarily:

Estate and GST taxes are currently repealed for 2010;

The gift tax is retained with a top rate of 35 percent and an exclusion amount of $1 million;

The stepped-up basis at death rules are repealed and replaced with modified carryover basis. With two major exceptions, the recipient of the bequeathed property will receive a basis equal to the lesser of the adjusted basis of the property in the hands of the decedent, or the fair market value of the property on the date of the decedent’s death;

Executors are able to increase the basis of estate property passing to anyone by up to $1.3 million, or $3 million in the case of property passing to a surviving spouse. Thus, an estate will be allowed to increase the basis of property transferred to a surviving spouse by as much as $4.3 million. However, the basis of an asset cannot be adjusted above its fair market value at the date of the decedent’s death; and

Executors of estates are also required to report certain details relating to transfers at death of non-cash assets in excess of $1.3 million and appreciated property received by the decedent within three years of death for which a gift tax return was required to be filed.

Annual Exclusion Unchanged

Some things are unchanged by the temporary expiration of the estate tax. One of these is the annual gift tax exclusion.

Although gifts of any property, including money, are generally taxable for gift tax purposes, under the annual gift tax exclusion an individual can gift a certain dollar amount per donee each year and a married couple can gift double that amount.

For 2010, the annual gift tax exclusion is $13,000, or $26,000 for a married couple electing gift splitting. Because this limit is per donee, an individual could, for example, gift $13,000 to each of her three children in 2010, with $39,000 being excluded from gift taxes; similarly a couple could gift $26,000 to each of their three children, with $78,000 excludable from gift taxes.

There is no gift tax on property given to a spouse who is a U.S. citizen or to a qualified charity. Other exceptions to gift tax that are not subject to the annual limit include qualified tuition or medical expenses paid directly to a medical or educational institution on behalf of a donee.

Impact of State’s Estate Tax and Inheritance Tax

Also unaffected by the expiration of the federal estate tax are the estate and inheritance taxes of several states.

Historically, states had followed federal estate tax law. Since EGTRRA, however, 12 states and the District of Columbia have retained their estate taxes, based upon the expired state death tax credit from the federal estate tax law, as a way of holding onto tax revenues. These states are Illinois, Maine, Maryland, Massachusetts, Minnesota, Nebraska, New Jersey, New York, North Carolina, Oregon, Rhode Island, Vermont and the District of Columbia. However, Illinois “recoupled” to the federal estate tax law with regard to the estates of persons dying after December 31, 2009, and the North Carolina statute provides that its state tax will be imposed only if a federal estate tax return is required. Consequently, no North Carolina tax is due for 2010 if the federal estate tax remains repealed. Kansas and Oklahoma have repealed their estate taxes effective for the estates of decedents dying after December 31, 2009.

In addition, three states – Connecticut, Ohio and Washington – have their own estate tax not tied to EGTRRA.

Eight states also collect an inheritance tax, which is solely a state tax assessed on the portion of an estate received by an individual (versus an estate tax, which is a tax assessed on the entire estate before it is distributed to individual parties). These states are Indiana, Iowa, Kentucky, Maryland, Nebraska, New Jersey, Pennsylvania and Tennessee. Assets transferred to a spouse are exempt from the tax, and some states also exempt assets transferred to children and close relatives.

The rate and amounts taxable vary considerably. For example, Arizona has no estate tax while Rhode Island and New Jersey tax estates over $675,000 and Ohio taxes estates over $338,333.

A Retroactive Tax?

The estate tax is sure to be on the congressional agenda early in 2010, both to end uncertainty as to what tax regime will be in place for this year and the future and to prevent a loss of revenue.

“Less than two percent of estates are subject to estate tax, but that still represents billions of dollars in estate tax payments each year,” Graziano noted.

House lawmakers approved the Permanent Estate Tax Relief for Families, Farmers, and Small Businesses Bill by a vote of 225 to 200 on December 3, 2009. That measure would have capped the tax at its 2009 rate, with a $3.5 million exclusion.

However, the Senate had several major problems with the bill, mainly its failure to allow for inflation adjustments and the use of the Statutory Pay-As-You-Go Bill of 2009, to fund the legislation.

Lawmakers have said they will revisit the tax early in 2010 and will likely approve retroactive provisions. However, the application of the estate tax retroactively could face constitutional challenges in court.

“The impasse concerning the estate tax is having an immediate impact on executors who find themselves administering the estates of decedents dying in 2010,” Graziano noted. “Due to the immediate effective date of the modified carryover basis regime, executors will be faced with an additional level of complexity with respect to decisions on selling or holding appreciated assets if the total appreciation exceeds $1.3 million. The sooner Congress makes its intent clear, the better for everyone.”

About CCH, a Wolters Kluwer business

CCH, a Wolters Kluwer business (CCHGroup.com) is a leading provider of tax, accounting and audit information, software and services. It has served tax, accounting and business professionals since 1913. CCH is based in Riverwoods, Ill. Wolters Kluwer is a leading global information services and publishing company. Wolters Kluwer is headquartered in Alphen aan den Rijn, the Netherlands (www.wolterskluwer.com).

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