Experts aren’t sure if the tax hiatus is a loophole or pitfall for estates. With taxes set to begin again in 2011, estate planners now wait and wonder how to determine a client’s current estate tax obligations.

In 2011 the estate tax is scheduled to return at a rate similar to that in place prior to tax cuts enacted under President George W. Bush.  The one-year repeal of the tax this year has been on the books for years, but estate planners and congress watchers have widely anticipated the congressional democrats would prevent the repeal from taking effect.

Instead, amid disagreement over the proper level for the tax and preoccupation with health care overhaul legislation, lawmakers punted last year and left the repeal intact.  Congressman Richard Neal (D-Mass.) said in a recent Wall Street Journal interview “Ten years ago, there was a lot of gallows humor about repeal when somebody said it would never happen.”  Neal chairs the House Select Revenue Subcommittee.  “Now, one of those never-happen moments has happened, and nobody’s laughing.”

Mr. Neal said “there is no question” that Congress will reinstate the tax,  retroactive to January 1.  That is also the intention of Senate Finance Committee Chairman Max Bacchus (D-Mont.).  But others aren’t so sure.

Veteran estate planner Steven J. Oshins, said in an interview with The Trust Advisor yesterday, “I am anticipating Congress will try to adopt an estate tax that is retroactive to January 1, 2010 in an attempt to fix the problem. However, it is not clear that a retroactive estate tax would be constitutional.”  Oshins added, “It is likely that there will be many lawsuits brought by wealthy families of decedents who die in 2010 prior to a retroactive estate tax system being adopted.”

University of Virginia Law School Tax Professor George K. Yin, said in a Wall Street Journal interview last week, “There are plenty of instances where Congress has changed tax laws retroactively but this one is particularly high profile.  Since Congress has had so much difficulty around a permanent estate tax solution to begin with, there is no reason to think a retroactive solution would be less controversial.”  There are big questions on whether the Democrats will even succeed with a retroactive extension.

All of this uncertainty has left the rich and their financial advisors with no end of planning conundrums and few opportunities. In addition to the estate tax, the so‑called generation-skipping tax also disappears in 2010.  That tax was imposed at 45 percent in 2009 on gifts to grandchildren.

Multimillionaires might try to take advantage of the repeal of the generation-skipping tax by making large gifts to grandchildren in 2010.  However, according to Oshins, those gifts would still be subject to a 35 percent gift tax still in effect for this year.

Therefore planning is definitely needed to make the right decisions.  For wealthy families it would be pennywise and pound foolish to not seek advice as to what to do considering the confusing status of the laws.

Pros and cons

Tax opponents argue that wealthy families should be able to pass the fruits of their hard work to heirs without getting whacked again by taxes. But some of the nation’s richest support the tax, saying it’s bad for the country to have a concentration of wealth among a small number of families.

The wealthy didn’t independently make all their money, but they benefited from living in a country with stable markets and a government that pours billions into research and subsidizes schooling for an educated workforce, says Bill Gates Sr., father of Microsoft’s founder.

“Society does have a just claim on these fortunes, and it goes by the name of the estate tax,” Gates said during a recent news conference on the tax.

Tax and legal experts say it’s difficult to advise clients now, other than telling them where things stand at the moment and to plan for a worst case scenario – a full retroactivity.

It appears, for the time being, we are left with three significantly different estate tax rules for 2009, 2010 and 2011.

Repercussions

Of course, heirs will like that a relative’s estate won’t be diminished by an estate tax. But they could face other problems from the 2010 tax repeal.

For instance, they will no longer get the benefit of a step-up in basis this year. This is where once you inherit, say, stock, the new cost basis for tax purposes will be the fair-market value of the shares at the time of your relative’s death. A step-up in basis reduces or eliminates any capital gains tax you might owe when you sell the securities.

But this year, heirs will need to find out the original purchase price of assets when they sell them, which could be a nightmare if dealing with stocks acquired decades ago that have undergone splits and reinvested dividends. While the law still allows a sizable step-up in basis, if assets have greatly appreciated, heirs could be hit with a capital gains tax bill.

Baltimore estate planning lawyer Jeff Gonya also points out that estate documents often refer to the federal estate tax, and now those documents will be out of date this year because the tax does not exist. This could have some unintended consequences, he says, such as disinheriting a child from a first marriage or a spouse from a second.

The unintended consequences raise serious questions about the validity of wills and trust documents handled this year.  Any ambiguity in a will or trust could become the basis for an heir suing a trustee for negligence or breach of fiduciary duty.

Trust officers should be careful to make certain that all estates are handled with proper care this year due to the expiration of the estate tax.

Kristen Simmons, a partner at Las Vegas based, Oshins & Associates, said many multi-millionaires may try to exploit this loophole by using the zero-tax regime as a reason to end their lives.  She added, “Similarly, a crazed family member of a wealthy parent or grandparent may decide that money is more important than a human life.”

Jerry Cooper, senior editor, The Trust Advisor Blog.

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