Effective January 1, 2010, several significant changes have developed in the areas of tax and estate planning. The purpose of this letter is to help you begin to evaluate what these changes may mean to your current plan. Some of these legislative changes may affect the way in which your assets are allocated to your beneficiaries, in contrast to what was expected when your plan was prepared.

SUMMARY OF CHANGES

• Federal estate and generation-skipping transfer taxes DO NOT apply to decedents passing in 2010 (this may affect your desired distribution). However, the exclusion amount, or specific dollar amount free of estate tax, will return to $1 million per person if Congress does nothing before January 1, 2011.
• The “step-up” in income tax basis of a decedent’s assets is now limited to $1.3 million for decedents dying in 2010, plus an additional $3 million for transfers to a spouse (decedent’s entire estate used to receive an unlimited “step-up”);
• The law regarding disinheritance provisions (“no-contest” clauses) has changed to limit the types of acts that may constitute a “contest” of a will or trust (current provisions in documents may not achieve desired result);
• The top federal gift tax rate is 35% for gifts made this year (may be a good time to make gifts and avoid future estate tax at potentially 55%); and
• No Adjusted Gross Income (AGI) limits for Traditional IRA to Roth IRA conversions (potential retirement planning opportunity).

FEDERAL ESTATE TAXES

Estate taxes are based upon the law at the date of death of an individual. There are two primary tax concepts utilized in estate plans to avoid estate tax on the death of an individual: (1) the federal estate tax applicable exclusion amount (“exclusion amount”); and (2) the unlimited marital deduction (“marital deduction”).

It may be uncertain how the provisions of your estate planning documents will be interpreted if there is no estate tax. This is because several provisions of your documents are phrased in terms of the exclusion amount or marital deduction. Since these tax concepts don’t apply this year, there may be some question as to what your documents mean and how your property will be disposed of. That in turn may cause tax questions to arise. To confuse the issue even more, Congress may retroactively apply the estate tax to individuals who die after January 1, 2010, but prior to any permanent change in the law later this year. While we can’t predict what Congress will do, if anything, we can design tax flexible estate plans, which would allow tax decisions to be deferred and made at the appropriate time to provide the best result.

GENERATION-SKIPPING TRANSFER (“GST”) TAXES

The generation-skipping transfer (GST) tax was created to simulate the tax results that would occur if family wealth were subject to an estate or gift tax at each generation. It was originally enacted to prevent taxpayers from avoiding estate or gift tax by transferring assets directly to generations below their own children. The GST tax does not currently apply to transfers made during 2010. While this may be a great benefit to some taxpayers, many estate plans are drafted to distribute assets pursuant to a formula based upon the existence or amount of GST tax. The uncertainty of the GST tax may cause unintended consequences to distributions from individuals’ estate plans.

CAPITAL GAINS TAXES: CARRY OVER BASIS

Another change that has taken effect this year relates to the income tax basis of inherited assets. Income tax basis is the value from which gain or loss on assets sold is measured. Under the law up until this year, the income tax basis of an asset is changed to its current value when its owner dies. However, as of January 1, 2010, the automatic change in basis will not occur. Rather, the deceased owner’s “step-up” in income tax basis is now limited to $1.3 million plus an additional $3 million for transfers made to a spouse. Allocation of your assets following the death of a spouse will affect how the $1.3 and $3 million limited “step-up” in basis is applied. Therefore, it may be appropriate for your documents to be revised in order to take full advantage of the new “step-up” limitations.

“NO-CONTEST” CLAUSES

Finally, the law regarding no-contest clauses has changed as a result of California State Senate Bill 1264, which passed in 2008, and which became effective as of January 1, 2010. A "No-Contest” Clause is a provision in trusts and/or wills designed to deter beneficiaries from contesting your estate plan.  It typically provides that any beneficiary who contests your plan will forfeit the gift they were to receive. This is especially useful if you plan to distribute your assets in any fashion other than equally to your descendants/heirs. The recent change in the law may render your existing no-contest clause unenforceable in some situations. Therefore, if your estate plan distributes your assets in a manner that may leave an individual disgruntled, we recommend that your documents be reviewed.

ADDITIONAL PLANNING OPPORTUNITIES

2010 may be a great year for making lifetime gifts of your assets.  The top federal gift tax rate has decreased from 45% in 2009 to 35% this year. The maximum gift tax rate is expected to go back to 55% in 2011. Therefore, if you’ve been considering making taxable gifts, 2010 may be the time to do it.

Additionally, effective January 1, 2010, there is no adjusted gross income limitation to determine who is eligible to roll traditional IRAs into Roth IRAs. A Roth IRA will generally grow “tax free” (as opposed to “tax deferred” Traditional IRAs), and will not be subject to the “required minimum distributions” beginning at age 70½.  The trade-off for this opportunity is that you will likely be taxed on the amount of IRA assets you roll over. Speak with your financial and tax advisors to determine if this makes sense for you.  

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