Tuesday, June 15, 2010

Planning For Dormant Estate Tax In 2010. What Happens In 2011? Why You Need To Seek Advice And Have Estate Plan Updated.

One reason I like to refer to articles in newspapers is that it helps explain to non-lawyers what is happening in estate and tax law. It also helps remind people when they need to engage in estate planning. The New York Times' article on June 12, 2010 is informative and is entitled "Confusion Over The Dormant Estate Tax Keeps Advisers Busy."

Why might you need to consult an experienced California estate planning attorney?

1. If Congress fails to act again this year, the estate tax laws next year will revert to their levels before 2001 which is $1 million.

This means that if you set up your estate prior to 2010 on the assumption that estates worth more than $1 million but less than $3.5 million or more would not be subject to estates taxes upon death will need to revisit their estate plan.

If the law stays the same and Congress does not act, the heirs of a single person who dies next year with more than $1 million would be subject to a 55 percent tax. (For couples, it is $2 million.) Heirs of that same person, with a $3.5 million estate, would have paid nothing in 2009 but could pay as much as $1.375 million in 2011, depending on the level of planning. The numbers speak for themselves.

2. How Can My Estate Be Worth Over $1 Million?

In California and the Northeast, the value of a home combined with retirement accounts means that a large percentage of the upper-middle class can have estates worth over $1 million (or $2 million for couples).

Estate planning can save a great deal of money and the cost of planning (flat fees in our office ranging from $3,500 to $5,000 for most estates) is minor compared to the savings in estate tax. See our prior article about "What Does Estate Planning Cost?"

3. Some wealthier clients are interested in creating grantor retained annuity trusts (GRATs) which is a short-term trust that allows people to pass money to heirs tax-free. There is a concern that the federal government could change the terms of these trusts. See our prior article about GRATs and other ways of transferring wealth.

4. For 2010, elimination of automatic step-up in basis requires determining the original purchase price and waiting for IRS to issue documents on how to apply artificial step-up in basis.

As discussed in other articles, in 2010 the automatic "step-up" in basis for capital gains tax purposes was also repealed. Here is a brief explanation of how this works. Prior to 2010, the assets of people who died under the old estate tax law were valued at the date of their death for tax purposes. For example, any capital gains on stocks purchased 20 years' earlier — which would have been subject to tax if sold — were erased. In 2010 that is no longer the case, and figuring out what is owed requires determining the original purchase price — however long ago that was.

Without an estate tax this year, the Internal Revenue Code grants an artificial step-up in basis, as it is called, of $1.3 million to be used at the executor’s discretion and $3 million on assets passed to a spouse. The problem is that the IRS has yet to issue documents or forms to record how this exemption has been applied.

For an estate where the deceased passed away in 2010, the tax would not be due until April 15, 2011. However, a problem could arise, for example, if the heirs need to sell stock for cash or to diversity holdings. The sale can be made but the heirs would incur a 15 percent capital gains tax on the appreciated amount.

The New York Times article gave one example showing how not having an automatic step-up in basis could affect property. For example, if an heir inherited a property worth less than $3.5 million (the 2009 exemption) but worth more than the $1.3 million (with a basis near zero) that the IRS step-up in basis would exempt -- there is a large difference between the taxes owed in 2009 and 2010. For a 2009 sale, there would have been no estate tax or capital gains tax owed. But if the property is sold in 2010, capital gains tax would be owed.

5. What do estate planning attorneys want to happen?

I cannot speak for others, but I (and most others I believe) want predictability and certainty in what the tax laws are going to be in 2010 and afterwards. Previously, it was predicted that the estate tax would be enacted retroactively but that has not occurred and may not. Given that the first billionaire has passed away in 2010 and has saved his estate an enormous amount of money, the IRS may not want to litigate against his estate which could easily outspend the IRS.

For the heirs middle-upper class who are moderately wealthy due to property and retirement plans, they will pay significantly more unless Congress acts to change the law. People who would not have had to worry about estate tax will need to plan if Congress changes the law or if Congress allows the tax to revert to 2001 rates.

6. What should I do if my estate is worth more than $1 million (or $2 million for couples)?

You can do a couple of things. First, have your estate plan updated before the end of 2010. There may be gifts and other estate planning vehicles available to you this year.

Second, watch what Congress does and plan to have your estate plan reviewed again in 2011. Depending on your net worth, the types of assets you own and your intended beneficiaries, it might turn out that you will not need the 2011 return visit — but we won't know until Congress acts or fails to act.

Posted by Henry J. Moravec, III. Henry (Hank) Moravec is a partner at Moravecs, A Professional Law Corporation. He has over 20 years' experience as one of the best Los Angeles estate planning attorneys and one of the best Los Angeles probate attorneys with an excellent tax law background and is available should you need legal advice regarding your own situation.

You can e-mail Hank Moravec at hm@moravecslaw.com or call him at (626) 793-3210 to request a consultation. The firm website is http://www.moravecslaw.com/. The firm is located at 2233 Huntington Drive, Suite 17, San Marino, California 91108.