Estate Taxes-Where Do We Go From Here?

It is now January of 2009-Happy New Year! The beginning of 2009 heralded an increase in the exemption amount for estate taxes, from $2 million to $3.5 million. This means that an individual passing away in 2009 may have up to $3.5 million in their estate without their estate being subject to federal estate tax. A married couple may have up to $7 million in their estate ($3.5 million each) before their estate is subject to federal estate tax.

Pursuant to the Economic Growth and Tax Relief Reconciliation Act of 2001 (hereinafter referred to as the “2001 Tax Act”), the estate tax will be completely repealed next year in 2010. This means that you could have an estate worth billions of dollars, and if you passed away in the year 2010, you would not owe a penny in federal estate taxes. However, in 2011, unless Congress acts to make the repeal of the estate tax permanent, the exemption will drop to $1 million, the same amount of exemption available in 2002, and the top estate tax rate will be 55%, the same top estate tax rate applicable in 2001.

California does not impose a state inheritance or death tax. California was previously known as a “pick up” state, meaning that California does not have its own separate state estate tax, but instead received a credit for state death taxes from the amount of the federal estate tax. The 2001 Tax Act phased out the state death tax credit in four years, hence the state death tax credit was eliminated on January 1, 2005. For answers to frequently asked questions regarding estate taxes in the State of California, visit the California State Controller’s Office website.

According to the Department of Finance for the State of California, California is currently facing a budget deficit of $14.5 billion. By June of 2010, the budget deficit is projected to grow to $28 billion, according to a recent article in the San Diego Tribune.

The Legislative Analyst’s Office for the State of California indicates that estate tax and the generation-skipping transfer tax accounted for an estimated $937 million in tax revenues in California in 1999-2000, prior to the enactment of the 2001 Tax Act. This was slightly under 2 percent of the total amount of tax revenue, making it the fifth largest source of general fund taxes.

Some have suggested that California create its own state estate or inheritance tax system. This would require an amendment of the California Constitution to allow the state to impose such a tax. Amending the California Constitution would require passage by a ballot proposition by California voters. To view California’s Revenue and Taxation Code sections pertaining to California estate or inheritance taxes, click here.

According to a December, 2008 article in the Silicon Valley Business Journal, an IRS supervisory estate tax attorney in California indicated his office hired 14 attorneys for the estate tax division, implying that the agency will be increasing the number of estate tax audits in the near future.

Over the last few years the IRS had actually decreased the number of attorneys working in the estate tax division. It appears that the IRS is now stepping up its efforts in estate tax collection. Many tax professionals feel that the IRS is adding to its arsenal of tax attorneys in anticipation that the estate tax exemption will be established at a permanent level sometime in the near future. The fact that the IRS is adding attorneys to its estate tax division certainly seems to imply that the IRS does not anticipate that the estate tax repeal will be permanent.

According to statistics from the Congressional Budget Office, in 2000, prior to the enactment of the 2001 Tax Act, only two (2) percent of all estates, or about 52,000 estates, were subject to any estate tax. The amount of the exemption for estate and gift taxes in 2000 was $675,000. If the 2004 exemption amount of $1.5 million had been in effect in 2000, only one percent of all estates, or 13,771 estates, would have been subject to any estate tax.

How much would permanent repeal of the federal estate tax cost in tax revenues? Permanent and full repeal of the federal estate tax is projected to cost $70 billion a year. With the current trillion dollar deficit, most agree that the United States cannot afford full and permanent repeal of federal estate taxes.

Most estate planning professionals believe that the estate tax will not be permanently repealed. Given the current federal deficit and the state of our economy, most feel complete and permanent repeal would be too costly in terms of the amount of tax revenue that would be lost. Most tax and estate planning professionals believe the exemption amount will be established at $2-3.5 million, indexed for inflation. Past discussions in Congress considered permanent increases in the exemption amount of up to $5 million.

Most practitioners are advising that you prepare your estate plan to provide flexibility and with careful consideration of the possible tax scenarios that may exist at the time of your death. Some estate planners have adopted a wait-and-see approach, but this runs the risk that you may lose the ability to plan due to incapacity, or that you will miss out on possible planning strategies due to poor health or advanced age.

In this time of uncertainty it is important to have an estate plan that considers the various possibilities with regard to estate taxes. If you already have an existing estate plan, it is advisable to consult with an experienced estate planning attorney to determine if your plan still accomplishes your estate planning goals or if it is in need of revision. If your existing estate plan uses a formula clause to determine the amount of the estate funding an Exemption or Bypass Trust, you should consult with your estate planning attorney to determine if your estate plan still comports with your wishes.

Here is an example of an estate plan that is in need of revision: Client created a revocable living trust ten years ago in 1999. Client’s children from a previous marriage are the beneficiaries of an Exemption Trust, with the balance of the estate passing to Client’s current spouse. At the time the trust was established, the applicable exemption amount was $650,000. Currently, the exemption amount is $3.5 million. Assuming the client passes away in 2009 with an estate of $4 million, the children would receive $3.5 million and the surviving spouse would receive only $500,000. This example illustrates how the shifting estate tax environment can impact the disposition of assets from the estate, often with unintended consequences.

If you have an existing estate plan and are unsure as to whether the current estate tax uncertainty may impact your estate plan, or if you have avoided planning because you were unsure of the possible estate tax ramifications, contact us by e-mail, or call us toll-free at (877) 435-7411 within California, or (858) 618-5510 outside of California to schedule a free consultation. The experienced estate planning attorneys at Law Offices of Scott C. Soady, APC will meet with you to discuss your planning objectives and possible estate tax consequences and assist you in formulating a comprehensive estate planning strategy.