Sovereign: Estate Tax in 2010…

Mark Nestmann (January 29, 2010)

While Congress was debating Obamacare last month, the U.S. estate tax ended on December 31, 2009.

Temporarily, that is.

If Congress does nothing, in 2011, the estate tax exemption reverts to its 2002 threshold—$1 million. If you’re a U.S. citizen or permanent resident, the balance of your estate will be subject to estate tax at a maximum rate of 55%. Tax lawyers grimly joke that they should advise their clients to die in 2010.

I don’t think estate tax will return to 2002 levels, but it’s possible. My best guess is that later this year, Congress will do away with the 2010 estate tax holiday and re-institute the federal death tax permanently. Numerous proposals are now before Congress. While the final outlines remain unclear, it’s likely Congress will:

• Keep the death tax exclusion at its 2009 level ($3.5 million). That exemption doubles to $7 million if you’re married and you and your spouse create a “credit shelter trust” before either of you die.
• Eliminate the 2010 death tax holiday
• Tax estates above the $3.5 million threshold at 45%
• Maintain the same exclusions for gift tax and generation-skipping tax (GST) as in 2009 ($1 million). (The GST targets transfers that skip one or more generations. For instance, absent careful planning, if Grandpa makes large gifts to his grandchildren, both gift tax and GST could apply.)

However, several proposals now circulating in Congress would crack down on popular estate-planning techniques. The one the IRS—and tax-loving congressional representatives—dislikes the most are “valuation discounts” associated with family limited partnerships and related entities.

The IRS has fought valuation discounts tooth and nail, but the courts have, with some exceptions, generally upheld them as reflecting market reality. But Congress may change that when it finally deals with the death tax.

One proposal would eliminate these discounts to the extent that they are claimed for passive assets such as securities, cash, or life insurance policies. Discounts would still exist for assets used in the active conduct of a trade or business.
Many estate planning attorneys—and their clients—complain that these provisions are overly harsh. Perhaps they are, but Congress is desperate to raise revenue, and valuation discounts are a handy target.

No one knows whether if valuation discounts for passive assets will survive estate tax reform. If they don’t, it’s possible discounts could be invalidated retroactively to Jan. 1, 2010. Consult with your tax advisors to consider the potential impact of this legislation on your estate plan.