What's New for 2010?

No Estate Tax!

Yes, it did happen. Remember this chart? Even though we have known this might be coming for several years, most estate planning professionals fully expected Congress to do something before 2010 arrived, even if it was only to extend the 2009 federal estate tax laws into 2010. But Congress did not act, so there is no federal estate tax this year.

Year "Exempt" Amount
2002 - 2003$1 million
2004 - 2005$1.5 million
2006 - 2008$2 million
2009$3.5 million
2010N/A (estate tax repealed)
2011 and thereafter$1 million

Note that this is not a permanent repeal. If Congress does nothing this year, the estate tax comes back in 2011 with a $1 million exemption and a top tax rate of 55%. The general consensus is that Congress will not address estate tax reform this year, leaving it as a campaign issue in the 2010 mid-term elections. So, for now, we have a new set of estate tax laws.

What does this mean to you?

Plan for 2010: Your current estate plan may include some formulas to save the maximum in estate taxes, make charitable gifts, and provide for your spouse, family and friends. In 2010, when there is no estate tax or marital deduction, these provisions may not work properly. For example, if you have beneficiaries other than your spouse, the current wording in your plan could cause your spouse to receive fewer resources than you had intended. Also, some states have their own death or inheritance tax, so even though there is currently no federal estate tax, your estate may still be subject to a state tax.

Plan for 2011 and Beyond: Unless you are certain of dying in 2010, you need to plan for 2011 and beyond. Remember, in 2011 the federal estate tax exemption is scheduled to be $1 million, and the top tax rate will be 55%. Compare this to the 2009 law, when the exemption was $3.5 million and the tax rate was 45%. There is no question that more families will be paying more in estate taxes in 2011. Just look at this chart for a quick comparison:

Federal Estate Tax
2009: $3.5 million exemption, 45% tax rate
2011: $1 million exemption, 55% top tax rate

Net Estate 2009 Tax 2011 Tax
$2 million$0$435,000
$3 million$0$945,000
$4 million$225,000$1,495,000
$5 million$657,000$2,045,000
$6 million$1,125,000$2,595,000
$7 million$1,575,000$3,145,000

Income Tax on Inherited Assets (2010 Only): The basis of an asset is the value used to determine gain or loss for income tax purposes when the asset is sold. Before January 1, 2010, assets that were inherited were automatically given a new "stepped-up basis" to full market value as of the date of the deceased owner's death. This saved the beneficiaries a substantial amount in income (capital gains) tax when the asset was sold. For 2010, the amount of assets that can receive a step-up in basis is limited. Assets that do not receive the stepped-up value will be taxed based on the deceased owner's original cost basis (what that owner paid for the asset). This means your beneficiaries could have to pay a considerable amount in income taxes when the assets are sold. Most estates will be able to step up $1.3 million worth of assets. An additional $3 million of assets left directly to a surviving spouse can also be stepped-up. But there are some complicated hoops to jump through to make this happen. (This change was implemented to help offset the loss in tax revenue from the one-year repeal of the estate tax.)

Generation Skipping Transfer Tax Repealed (2010 Only): For many years, the generation skipping transfer tax has applied to assets that "skipped" the living parent (your child) and went directly to a grandchild. It is in addition to the federal estate tax. This tax was also repealed for 2010, but it is scheduled to come back in 2011 with an approximately $1.5 million exemption and a 55% tax rate. By comparison, in 2009 the GSTT exemption was $3.5 million and the tax rate was 45%.

Roth IRA Conversions: Previously, if your adjusted gross income was $100,000 or more, you did not qualify to convert your tax-deferred savings to a Roth IRA. But beginning in 2010, the income restriction has been eliminated, so everyone is now eligible to convert to a Roth IRA. Of course, you will have to pay income taxes on the amount you convert. But if you do the conversion this year, in 2010, you will be able to claim half of the conversion amount as income in 2011 and half in 2012. This offer from Uncle Sam is a "limited time offer" and is only available this year. After 2010, you can still do a conversion but it will all be included in that year's income. If you are interested in a Roth IRA conversion, be sure you meet with a qualified advisor and look at some projections before you convert.

What Should You Do Now? Now is the time to have your estate plan reviewed by your attorney. Remember, your plan needs to reflect the tax laws that are currently in effect. Some changes will probably need to be made to make sure your assets are distributed the way you want and to maximize income tax savings. Also, there are several estate tax planning options that may not be available for much longer. Now is the time to take advantage of them while we still have them. And, depending on what Congress does or doesn't do to reform the estate tax law, be prepared that more changes may need to be made later.