EGTRRA – The Good, The Bad and The Evil


EGTRRA Changes – The Good, The Bad and The Evil

By Minda Parrish

Well, Mike Rowe with America’s Dirtiest Jobs would feel right at home with the mess Congress has created with the repeal of the federal estate tax.  Pull out your hip boots, buddy.  You’re going to need them.  The repeal ranks right up there with the best of them!

Although we have known since the beginning of the 21st Century that the federal estate tax and generation-skipping transfer tax (GSTT) was scheduled for a one-year repeal beginning January 1, 2010, few of us believed it would actually happen.  Most authorities felt certain that Congress would take steps to preclude the law from playing out.  They didn’t.  For now, the estate and GSTT repeal is upon us like a dark cloud, boding evil on our beloved estate tax exemptions.

When President George W. Bush signed the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) into law, it was intended to provide considerable and “permanent” tax relief from the federal estate tax.  At that time, there was a $675,000 exemption and the maximum tax rate was 55%.  Little by little, the new law reduced the maximum estate tax and GSTT rate to 45%, while the exemption amounts soared to $3.5 million in 2009.  In 2010, the federal estate tax and GSTT were eliminated altogether.  However, a special Senate rule limits budget deficits, so the EGTRRA was passed with a “sunset” provision which mandates that the law will revert back to the pre-EGTRRA law on January 1, 2011.  This means that the federal estate and gift tax exemptions will be unified at $1 million, the GSTT exemption will be $1 million (which was adjusted for inflation) and the maximum tax rate will be 55%.  As a side note, the unified credit was scheduled to increase under prior law.

You may want to bypass the hip highs and go straight for a shovel since Congress substituted another method of taxation that will collect far more taxes from your clients and unsuspecting families than the estate tax ever did.  Before New Year’s Day 2010 (with some exceptions), assets owned at death received a basis “step-up” to the asset’s fair market value on the date of death.  Simply put, if a client died with publicly-traded securities in his or her possession that were purchased many years ago, the beneficiaries were permitted to sell the stock and pay little or no income tax – other than the tax on the difference between the sale price and the fair market value on the date of death.  As always, the stock was included in the client’s gross estate for estate tax purposes.  Enter EGTRRA.

Under EGTRRA 2010 (a.k.a. Extremely Goofy Tax Rigmarole Requiring Aleve), a beneficiary who receives property from a deceased person gets it with an adjusted basis equal to the lesser of the decedent’s basis or the asset’s fair market value on the decedent’s date of death.  Thus, EGTRRA eliminates the automatic “step-up” to the date-of-death value but retains a “step-down” for depreciating assets.  It’s easy to see why this modified carryover basis system will impact far more people than the estate tax ever would!

To offset the loss of the “step-up,” EGTRRA provides that the person in charge of the property may allocate a $1.3 million “aggregate basis increase” on an asset-by-asset basis up to the particular asset’s fair market value at the date of the decedent’s death.  Assets left to a spouse may receive an additional $3 million “spousal property basis increase,” also asset-by-asset, up to the particular asset’s fair market value at the date of the decedent’s death.

To be eligible for either step-up, the property must be owned by the decedent.

For purposes of the $3 million spousal property basis increase, the property must be left to the surviving spouse alone, either outright or in a special trust known as a “QTIP” (Qualified Terminable Interest Property) trust.  Without the necessary modifications to meet these requirements, many marital trusts in existence will not qualify and will waste $3 million of basis increase.  On the other hand, assets that are left entirely to the surviving spouse can upset clients’ estate planning goals and objectives, accidentally disinherit children from previous marriages, and leave the assets exposed to the surviving spouse’s creditors and predators.

As the estate tax law debate drones on in Congress with no decision being made on a potential retroactive estate tax, the Tax Policy Center estimates that there will be approximately 43,500 estates subject to estate tax in 2011 if the exemption is $1million.  However, there would be approximately 6,500 estates subject to estate tax if the 2009 exemption amount of $3.5 million is in place – a significant difference.  With the pending election and politics at play, odds are good that Congress won’t act on the estate tax law before December.  Can you imagine all the lawsuits that would be filed if they tried to pull something like that off with such late notice?  I shudder at the thought.

The Senate is in a political pressure cooker.  Oil tycoon Dan Duncan from Houston died with a $9 billion estate.  The government lost $2-3 billion on that estate alone.  Yes, I said billion.  Then there is New York Yankees owner George Steinbrenner who passed away with an estimated $1.1 billion estate.  He hit a “GRAND SLAM” by dying in 2010 with no estate tax!

All of this is pitiful, but true.  In the midst of the deadlock (pun intended), two patterns of compromise by the Senate are surfacing.  One is that the estate tax exemption will start at $3.5 million and then climb to a higher number over ten years.  The other is that the estate tax rate will begin at 45% and then decrease again over the same time frame.
On July 14, 2010, Senator Blanche Lincoln (D-AR) and Senator John Kyl (R-AZ) introduced an amendment to H.R. 5297 (the Small Business Lending Bill) which would modify the estate tax rules. Senators Kyl and Lincoln claim that they now are close to the required 60 votes in the Senate for passage of their compromise on estate taxes. The bill includes five guidelines:

  1. Phase In – The increased exemptions and reduced rates would be gradually phased in over a period of ten years.
  2. Estate Exemption – The exemption would start at the 2009 level of $3.5 million and increase to $5 million by 2020.
  3. Estate Tax Rates – The 2009 estate tax rate of 45% would be reduced by 1% per year to 35% by 2020.
  4. Optional 2010 Rules – For estates of 2010 decedents (such as the decedents of  Houston oilman Dan Duncan who passed away in March with an estate of $9 billion) there is an option to use the 2009 exemption of $3.5 million or accept the 2010 rules with no estate tax and a loss of the step up in basis.
  5. Tax Offsets – The Senate Finance Committee is tasked with finding additional new taxes that offset the cost of increasing the exemption from $3.5 million to $5 million and reducing the top estate tax rate from 45% to 35%.

Majority Leader Reid (D-NV) has not yet indicated whether he will permit a vote on this motion. If the 60 votes in favor of this compromise are available in the Senate and he permits a vote, then the House will need to consider the compromise. In the past, the House majority has been quite partial to extending the $3.5 million exemption without additional increases.

So, what does all this mean to existing estate planning documents?  Great question.  I’m glad you asked.  For married couples, living trusts and wills typically use a formula to divide the decedent’s property into the credit-shelter trust (also referred to as the “Bypass” or “Family” trust) and a marital trust to maximize the amount that will pass free of estate tax. If clients created their estate plan when the federal exemption was much lower, this common estate planning language will force the trustee to put more assets into the credit-shelter trust than is necessary.  This would make the marital trust bare bones and would not take advantage of the special basis adjustment options under the modified carryover basis rules discussed above.  This will have no significance when the family and marital trusts contain identical beneficiaries and dispositive provisions.  However, if the family and marital trusts contain different beneficiaries or different dispositive provisions (which is common in second marriage situations, especially where there are children from a prior marriage), this may cause dire consequences to the surviving spouse – potentially disinheriting the surviving spouse if death occurs in 2010!

What should your clients do now?  Since most advisors did not anticipate EGTRRA playing out in 2010, virtually all clients’ estate plans fail to take into consideration the lack of estate tax exemptions and its replacement, the modified carryover basis rules.  Many clients who understand that the estate tax is repealed will automatically assume that the result for them and their families will be positive or neutral. Unless clients are forewarned about the dangers of the federal estate tax and generation-skipping transfer tax by YOU, their trusted advisor, their hopes and dreams for their loved ones could be crushed.  Never in their wildest dreams would they imagine that it’s not only possible that more tax will be paid after their death without a revision to their estate plans, but that the amount and nature of the assets that they expected to go to their spouse, family, friends and charity may be grotesquely different than they had planned.  They simply must be told.

The good news is that you and I can help.  The key is flexibility.  It’s crucial that clients’ estate plans contain enough flexibility to accomplish their goals under changing circumstances.  Life happens.  This estate tax discussion is a perfect example of that.  Therefore, we strongly encourage clients to have us review their estate plans to ensure they continue to meet their objectives while minimizing all tax.  We hope you’ll do the same.  It’s a TEAM effort – Together Everyone Accomplishes More.

There are no comments yet. Be the first and leave a response!

Leave a Reply

Wanting to leave an <em>phasis on your comment?

Trackback URL