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Estate and Tax Planning for 2010 & 2011

As you may have heard, the federal estate tax rules changed radically in 2010 and could change radically again in 2011 unless Congress passes new legislation. This letter is intended to advise you of what has happened and encourage you to reevaluate your estate plan as soon as possible.
 
2001 Tax Act. In 2001, Congress passed the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) which provided for significant phased-in increases in the federal estate, gift and generation skipping tax (GST) exemptions and lower tax rates. EGTRRA provisions included:
 
·         In 2009, the estate and GST exemptions increased to $3.5 million per decedent, with a flat 45% estate and GST tax rate on any excess. The gift tax exemption was $1.0 million, with tax rates from 41% to 45%.
 
·         In 2010, the federal estate and GST taxes were repealed for one year. The gift tax $1.0 million exemption remained, with a lower flat tax rate of 35%. Thus, you had to die or pay gift tax to get the benefit of the change. The step up in basis rules (which gave a “fresh-start” fair market basis for most assets of a decedent) was replaced with an adjusted carry-over basis. These new basis rules permit a step up in basis of up to $1.3 million, plus an additional $3.0 million for certain spousal transfers at death.
 
·         On January 1, 2011, EGTRRA was automatically repealed, resulting in an odd situation: A $3.5 million estate and GST exemption and flat 45% tax rate in 2009, no estate and GST tax in 2010, and a $1.0 million estate exemption and tax rate up to 60% in 2011.
 
What Happened in 2009? Estate planning practitioners universally expected Congress to carry the 2009 estate tax rules across 2010 (both Representative Rangel as Chair of the House Ways and Means and Senator Baucus as Chair of the Senate Finance Committee said it would happen earlier last fall). However, unexpectedly in December the House failed to act on a one year extension and instead sent the Senate a bill to make the 2009 rules permanent. Because the Senate was focused on health care and there was broad disagreement in the Senate on what to do with estate taxes, Congress enacted no changes to the EGTRRA’s 2010 rules. Thus, effective as of January 1, 2010, there is no federal estate or GST tax.
 
Planning in Chaos. Congress’s failure to adopt estate tax legislation in 2009 and the possibility that changes will not be adopted during 2010, radically change the estate planning considerations of many clients. For example, Congress has indicated that in 2010 about 6,000 decedents will benefit from the elimination of estate taxes, but over 70,000 heirs will pay higher income taxes because of the change in the income tax basis rules for assets received from decedents.
 
2010 Changes. The U.S. has an unpredictable planning environment in which any number of radically different changes may occur in 2010:
·         Congress may do nothing in 2010, in which case there is an adjusted carryover basis, and no federal estate or generation skipping tax for people who die in 2010. While you probably will not die in 2010, you still need to consider planning for that possibility, because not planning for these changes, if death occurs, can be disastrous. For example:
  • Formula clauses (e.g. terms that allocated your estate exemption to a “by-pass trust”) in your planning documents could inadvertently disinherit some heirs and/or your surviving spouse and/or create conflicts among family members on how your documents should be properly interpreted.
  • Conflicts could arise among your heirs and fiduciaries on asset basis issues.
  •  Inadvertent generation skipping taxes could be incurred after 2010.
  • Passing assets directly to your surviving spouse may result in higher estate taxes after 2010.
  • Inadvertent state taxes could be incurred from out of date terms in your documents.
Congress may adopt legislation to carry the 2009 rules over 2010, retroactive to January 1, 2010. There is broad disagreement on whether a retroactive tax bill is constitutional. If a retroactive law it adopted, it will be challenged as unconstitutional and it could take years for the Supreme Court to rule on the issue. Until such a ruling, uncertainty will prevail. Those dying after the enactment should not have that uncertainty. In any event, your estate plan should contemplate dying both before or after a potential retroactive enactment, which may or may not be constitutional.
 
If Congress acts in 2010 to address the estate tax issues, it could:
  • Adopt permanent estate tax exemption, beginning in 2010 or 2011. If so, most commentators anticipate estate tax exemptions to fall between $2-5.0 million and tax rates 35% to 45%.
  • Adopt a temporary higher estate exemption.
  • Adopt rules to limit or eliminate valuation discounts
2011 Changes. Unless Congress enacts new legislation in 2010, then on January 1, 2011, a number of automatic changes occur to the federal tax code, including:
  • The estate tax exemption drops to $1.0 million per decedent.
  • The estate tax rate increases (e.g., 55% above $3.0 million and 60% above $10 million).
  • States which remain “coupled” to the federal estate tax will have their state death taxes restored. Thus, if you own property in one of these coupled states, you could have new exposure to a state estate tax.
  • The fair market value step up in basis returns for assets passing from a decedent.
  • The top income tax rates go up by at least 4.6%, capital gain tax rates go up by up to 5% and dividend tax rates go up by up to 24.6%.
 
Higher Taxes. No matter what happens to the estate tax, substantial tax increases are looming. A $12 trillion deficit is projected for the next decade. The Congressional Budget Office indicates that the social security trust fund will pay out more then it receives starting in 2011 or 2012. Taxes will have to increase across a broad range of Americans. Both the Washington Post and the New York Times have stated that the President will have to abandon his pledge to only increase taxes on taxpayers earning over $250,000. Given slow economic recovery and the fact that we are in a mid-term election year, the federal government will probably not increase taxes until sometime in 2011. While substantial tax increases are likely, we just don’t know any details.
 
ROTH IRAs. In 2010, taxpayers can convert traditional IRAs to ROTH IRAs and can pay the income taxes due on such conversion in 2010 or equally in 2011 and 2012. There are significant benefits and traps for the unwary in making these decisions.
 
Effectively, unless Congress adopts new legislation, in 2010 the estate tax rules rotate 180 degrees from where they were in 2009, and then rotate 180 degrees again in 2011 – only the estate tax and income tax rules could be even worse than what we had in 2009. Uncertainty makes it difficult to plan, but waiting to see what happens next is not a good idea. The earlier you can implement flexible tax and estate planning to respond to these changes the better.
Please call us to schedule a time to go over your current estate plan and determine what changes may need to be made to your current plan to minimize taxes and to reduce the possibility of future family conflicts in these chaotic times. Unless we otherwise hear that you want to engage us to review your existing plan, we will not begin that process.
 
*Tax Disclosure: The above should not be construed as tax advice. Please consult your tax professional for information specific to your financial situation.
 

 The Death Tax Is Likely To Live On, So High-Net Worth Individuals Might Consider a Qualified Personal Residence Trust 

The Obama Administration has indicated its plans to block the estate tax from disappearing in 2010, though to offer a bit of relief, it might freeze it at the rate and exemption levels that took place this year.
  
That would mean that estates worth up to $3.5 million for individuals and up to $7 million for couples would be exempt from any taxation and those above those amounts would be taxed at 45 percent. (At the end of the Clinton Administration, estates of less than $1 million would be excluded with the rest taxed at a 55 percent rate.)
 
Even with the downturn in the real estate and stock markets, it’s a good time for high net-worth individuals and couples to look at ways to shelter their estates from the possibility of taxes going forward. One possibility for couples who have a substantial investment in real estate they consider a residence is the Qualified Personal Residence Trust (QPRT). A QPRT is a trust that owns the home at a discounted value for a specific term while allowing the parents to continue living in the home.
 
The QPRT works best for those people who expect to live another decade or so. The longer the term of the trust, the greater the benefit to the kids. Yet you’re essentially playing a game of chicken with the Grim Reaper—if one or both of the parents die before the trust expires, the heirs have to pay the estate tax on the value of the house at the time the parent died.
 
A good first step in finding out if a QPRT makes sense is a trip to see your professional or your tax or estate planner. Such a trust has to be set up carefully with a thorough review of actuarial tables and a discussion of each parent’s financial history.
Technically, QPRTs make the most sense when interest rates are high, because the higher the interest rate, the greater the discount applied to the property, which, in turn, increases the tax savings. A QPRT is based not on the current value of the house at the time the trust is being written, but what is determined to be the present value of a future gift, which is actually a discount to the current value. When a home is put into the trust its value is not the current value of the house, but what is called the "present value" of the future gift - a decrease of 25-50 percent in value. The Internal Revenue Service calculates these formulas, so ask your expert how current calculations will affect the value of your estate.
Another potential benefit of the QPRT is that if the parent runs into trouble with high hospital or medical bills, the hospital cannot demand any money gained by refinancing or selling the house, since the occupant does not have any right to that money.
If the rough real estate market has devalued your home at least a little, chances are that the market may rebound sometime during the term of the trust and if you outlast the trust at its expiration, the strategy may work out very well for your heirs.
Obviously there are a number of considerations here, not the least of which involves the current value of the property. Your adviser should help you consider all these issues, and you should keep an eye on the news for what eventually happens with the capital gains tax as well as what ends up happening with the estate tax.
Oh, and if the parent outlives the trust, the parent can continue to live in the house by paying the kids fair-market rent. There’s one more wrinkle to try if the kids want to avoid income taxes on the rent they’ll receive from their parents—they can form a grantor trust for the property so the rent is paid to the trust.
 
Is Your Child Headed To College Next Fall? It’s Time for Both of You to Take a Crash Course on Borrowing and Spending
 
Even if you’ve planned relatively well for your future college student’s expenses, the credit crunch and downturn in investment income for colleges have changed the game for financial aid at many schools. That means both parents and students need to approach the college financial aid scene with unprecedented caution. 
 
Harvard University, the world’s richest school, announced in February that it was slashing 25 percent of its investment staff after its $36.9 billion endowment lost 22 percent of its value in the previous four months and could decline as much as 30 percent by the end of June. In two separate surveys released in January, the Commonfund Institute and TIAA-CREF, in a survey done for the National Association of College and University Business Officers, reported that college endowments fell on average 23 percent in the five months ended Nov. 30, 2008.
 
Why is this important? It’s true that endowments at schools of all sizes mostly pay for faculty and facilities. But they also provide both grants and scholarships for talented students who need them and have been under significantly more pressure to do so. When students have a tougher time finding lower-cost school financing, the demand for scholarship and grant funding goes sky-high. In many cases, students are forced down the borrowing chain to increasingly risky loan options.
 
The private student loan sector has also been hit by reports of questionable practices in the last two years. In December, New York Attorney General Andrew M. Cuomo reached an agreement with the College Board – the developer and administrator of the SAT and AP – to stop discounting products and services in exchange for a ranking on colleges’ preferred lenders list. The College Board will now invest $675,000 to develop a set of tools to help financial aid administrators to help students and parents compare student loan offers and identify the lowest-cost loan options.
 
What can you do? One of the best starting points is a meeting with a professional with specific expertise in planning for college and financial aid options. The smartest thing is to work with a planner when kids are young to amass the right amount of savings for college, but it makes good sense for both parents and students to meet with a planner before school starts to underscore the complete list of financial issues the student will face. These include:
 
Planning alternatives for financial aid shortfalls: Over the past few years, colleges have not been able to offer adequate amounts of funding through Perkins, Stafford and Plus federal education loans, and private student loans through banks have closed up with the credit crunch. For students already admitted at schools for their freshman year in the fall, financial aid letters will start going out this month.
 
Here’s the catch – many college students get in trouble with debt because they are unaware that many for-profit companies advertising access to federal loans pull their financing from private sources that cost the borrower far more than actual federal loans would. The ability to plan for college well in advance and work with an expert to sift through proper loan alternatives can make the difference between an affordable debt load when a student graduates and potential bankruptcy.
 
Setting a budget as early as possible for basic expenses: Until the student gets to school it will be tough to tell what actual expenses will be, but it won’t hurt to set a tentative budget that involves taking full account of the student’s savings, the parents’ (and possibly the grandparents’) contribution to everyday expenses and any planned income from work-study or other sources. For a template of a budget written specifically for college students, go to: http://www.aie.org/Calculators/budgetworksheetinschool.cfm
 
Start managing credit and debit cards before school starts: The time to start managing credit and bank accounts isn’t freshman year. While a teenager won’t build a credit history as an authorized user on a parent’s card, it’s good to get a little practice using it under a parent’s watchful eye. When a child goes on to college, the challenge will be looking for the best credit card offer amongst many and managing that credit responsibly. This is another good reason for both parent and student to meet with a financial planner ahead of school to discuss proper credit card usage and monitoring of a student’s fledgling credit score.
 

 

 

 

Goldstrand Planning Group
2800 W. March Lane, Suite 326
Stockton, CA 95219-8202
Toll Free 1-800-507-9911
(209) 472-7000
FAX: (209) 472-1551
e-mail: planning@goldstrand.com