The Estate Tax Mess
Mrs. Bea Fuddled (Bea) is exactly what her name implies, befuddled. It seems that Mr. Fuddled died in January 2010, leaving a Revocable Living Trust (RLT) with most of the family’s assets in it. If you want more information about RLTs and estate planning, please visit the other pages on our website dealing with Estate Planning and read the “Plain English Explanation of Wills and Trusts.”
Mr. Fuddled’s RLT was drafted many years ago and it used an estate tax marital deduction formula to determine how much assets to place in a trust for Bea. At the time, it was assumed that this would be enough for Bea’s needs, so the Trust did not allow Bea to share in what is commonly called the Family Trust or the Bypass Trust. Bea has just learned that no assets will be allocated to the trust for her, nor does she have the right to withdraw assets from Mr. Fuddled’s RLT, which is now irrevocable.
How did all this come about? In 2001, the Bush administration and the Republican-controlled Congress, desiring to repeal the estate tax but not being able to fit a full repeal within the necessary budget parameters, enacted a compromise that repealed the estate tax for one year — 2010. Well, that one year is now here, and Bea is seeing some of that law’s effects.
Funding a trust for the surviving spouse based upon the amount of the marital deduction necessary to eliminate all estate tax is a common mechanism used by our firm and others. In the past this approach worked well and was both flexible and eliminated all of the estate tax when the first spouse died.
In Bea’s case, however, because there is no estate tax, there is no need to claim a marital deduction and hence Bea gets nothing from her husband’s trust. Better planning could have avoided this problem, but Bea may not be the only person in this situation.
Unfortunately for Bea, as written, her husband’s trust does not allow her to receive distributions of income or principal from other trust assets. Put another way, the unexpected contingency of not having a federal estate tax for one year has resulted in all of the assets going to the part of the RLT of which Bea is not a beneficiary.
Bea’s situation is a lesson for all. No matter how good a Will or trust is when it was created (and Mr. Fuddled’s was not the best), the passage of time as well as economic and tax law changes can wreak havoc with even the best plans. This is why estate plans should be reviewed periodically and, if necessary, changed to keep up with the times.
The same tax law that helped create Bea’s problem, also created another set of problems for heirs of persons who die in 2010. The is the so-called “carryover basis.” Prior to 2010, heirs who received property from a deceased person through a Will or trust received a stepped-up basis — i.e., the tax basis was the fair market value on the date of the person’s death. To help “pay” for the estate tax repeal in 2010, Congress eliminated the step-up in basis for 2010, meaning that many inherited assets will have the same tax basis as the person who originally owned them. As previous newsletters have noted, this creates all sorts of problems for heirs.
As the law now stands, in 2011, the estate tax will come back to life with higher tax rates and a smaller lifetime exemption ($1 million) than was in effect in 2009 when the exemption was $3.5 million. It is expected by many that Congress will, at some point reinstate the estate tax, perhaps in terms similar to those that were in effect in 2009. Perhaps this change will be made retroactive to January 1, 2010, thereby, in effect, repealing the repeal of the estate tax.
In the meantime, what can be done? The sad truth is that no one knows with any certainty what the estate tax law will be for the remainder of 2010 or beyond.
Nevertheless, here’s what needs to be kept in mind. If you are an executor or trustee for a person who died in 2010, do not immediately distribute all assets or take any other action based on the assumption that the estate is completely repealed for 2010. It may be back!
As in Bea’s example, now is the time to review and, if necessary, revise estate plans to make sure that they work as intended taking into account the legal and economic changes since they were first created.
If you need assistance in planning, implementing, or reviewing your estate plan, call Newland & Associates.
Copyright 2010
Published by the law firm of Newland & Associates, PLC
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