Estates and Trusts Alert | Winter 2010

2010: The Year of No Estate Tax! In 2001, Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) to reduce taxes and thereby stimulate the economy following September 11th. Among other things, EGTRRA included changes in the estate tax laws which gradually increased the exemption over an 8-year period. Last year, a person could pass away with $3.5M in assets without paying a federal estate tax. However, EGTRRA provided a one-year repeal of the federal estate and generation-skipping transfer taxes for 2010. Due to Congressional inaction at the end of 2009, the “promises” of EGTRAA have become a reality:

  • The federal estate tax has been repealed for individuals dying in 2010.
  • The federal generation-skipping transfer tax will not apply to transfers made in 2010.
  • The federal gift tax rate has dropped to 35% for taxable gifts made in 2010.
  • Individuals inheriting property in 2010 will no longer receive a “step-up” in property basis for federal income tax purposes.

Today’s Dilemma: How do you advise your clients? The current tax situation makes it important for your clients to review their estate planning documents to ensure that they still carry out their intentions. For example, if your client’s Will (or Trust Agreement) leaves an amount to their spouse, children, or a trust for their benefit and the amount is defined by “marital deduction,” “unified credit,” “available exemption,” “available credit,”; OR their Will (or Trust Agreement) includes the terms “Credit Trust,” “Marital Trust,” “Exempt Trust” or “Non-Exempt Trust”, then their documents should be reviewed by a qualified estate planning attorney to ensure that there no tax consequences due to the federal tax laws that now exist in 2010. NOTE: Please remember that Maryland still has an estate tax! In 2002, Maryland “decoupled” from the phase-out of the federal credit for estate taxes and implemented a $1M exclusion. This means that a Maryland estate tax return is required for estates whose gross estate plus adjusted taxable gifts is valued at $1,000,000 or more. Your clients may need to have their will or trust provisions revised to reflect the disparity between the federal and Maryland laws! EGTRAA and Income Tax The step-up in basis for assets inherited from a loved one is gone! Prior to 2010, assets inherited received a “step-up” in income tax basis. The basis was “stepped up” to the asset’s fair market value as of the date of death. That rule is no longer in effect for 2010. If your client inherits an asset from a deceased person’s estate, the tax basis in that asset is either the decedent’s cost basis or the fair market value as of the date of death, whichever is lower! Take for example Lonely Lilly. In 1979, Lonely Lilly purchased waterfront property for $250,000. Lonely Lilly died in October of 2009. The fair market value of the property as of Lonely Lilly’s date of death is $1,000,000. Her beneficiaries will receive the property with a “stepped-up” basis of $1,000,000. However, if Lonely Lilly died in 2010, her beneficiaries would receive the property subject to Lonely Lilly’s basis: $250,000! There is relief available, however. The current laws allow a Personal Representative to increase the basis of the decedent’s assets up to $1.3 million. So, in the example above, Lonely Lilly’s Personal Representative could increase the basis of her property from $250,000 to $1,000,000. Now if Lonely Lilly was married at the time of her death (“Married Lilly”), and she is survived by a spouse, an additional $3 million of “basis increase” is available to allocate to assets passing directly to the surviving spouse or to a qualified trust created for the surviving spouse’s benefit (a “QTIP” trust). A good habit to get your clients into is to have them keep accurate records of their capital assets. The records should, at a minimum, include the price they paid for that asset. Their Personal Representative or Trustee (and you!) will be forever grateful for these records especially if they are required to ascertain the amount of taxable gain when an asset is sold. Predicting the Future 2011 brings yet another major change; EGTRRA is scheduled to “sunset” at the end of this year.Unless Congress acts before the end of 2010, the estate tax laws will revert to the provisions that were in effect in 2001. That means:

  1. The federal estate tax and GST tax will return;
  2. The estate and GST tax exemptions will decrease to $1,000,000;
  3. The maximum estate and gift tax rate will increase to 55%; and
  4. Assets will once again receive a “step-up” in basis

It is uncertain what Congress will do in 2010 with respect to the estate tax. Perhaps, they will abolish the estate tax forever (not likely). Maybe the exemption amount will be raised to $3M. IT ANYONE’S GUESS! As a result, we as advisors must be proactive and discuss with our clients any and all options available to them. It you or your clients have any questions or concerns about how the estate tax laws affect their estate plans, please give us a call. Roth IRA Conversion: What is best for your client? If it hasn’t happened already, be prepared to answer your clients’ questions on whether a Roth IRA conversion is appropriate for them. What should you say? What do you need to know? The answer as you may very well guess is “it depends”. Some advisors believe the Roth conversion to be a rare opportunity to counsel their clients to circumvent increases in personal income taxes, build flexibility in their retirement plan and increase the goals of transferring wealth to their loved ones. Others, however, see very limited benefit from the conversion, especially for their clients who are close to retirement. Many advisors are already aware that prior to January 1, 2010, IRA owners could only convert from a traditional IRA to a Roth IRA if their adjusted gross income (AGI) was less than $100,000. For this year only, IRA owners (whether those IRAs are deductible or non-deductible), have the ability to convert the IRA to a Roth IRA regardless of income. So why consider the Roth? The major benefit of converting to a Roth IRA is that earnings and withdrawals are income tax free so long as the individual (i) has held the Roth IRA for a minimum of five years from the date of conversion and (ii) is at least age 59½ at the time of withdrawal. In contrast to a regular IRA, a Roth IRAs have no required minimum distributions after age 70½ — an extremely powerful benefit. The tradeoff for this benefit is that conversion from a traditional IRA to a Roth IRA is treated as a taxable event. That is, the IRA owner reports the income tax on conversion as if she took a distribution from the account. The IRS, however, does give the taxpayer a small break as she may choose to pay income tax on the entire converted amount in 2010 or have one-half of the taxable converted amount taxed in 2011 and the other half in 2012. Of course by paying the income tax on the IRA upon conversion, the benefit for the more affluent client is that the client’s taxable estate would be reduced by the amount of income tax paid in the conversion. Why advise a client to convert? 1. Conversion may be a great benefit to your clients who might be in a higher income tax bracket at retirement either because of personal economic factors or because income tax rates could rise. Converting may thus enable your client to pay less now rather than more later. 2. Clients who are concerned about outliving their assets may wish to convert to a Roth IRA as Roth IRAs do not have required minimum distributions like traditional IRAs. And of course all Roth distributions are received income tax free. Aside from the obvious, how might this be an advantage? Here is one example of how it could work to a client’s advantage. Once an individual’s income exceeds a relatively low threshold, up to 85% of Social Security benefits received are taxable as ordinary income at the taxpayer’s marginal tax rate. The advantage of Roth IRA distributions is that they are not counted under the category of “tax-exempt income” nor as taxable income that goes into the calculation to determine the amount of the Social Security benefits received that will be taxable at the taxpayer’s marginal rate. 3. Those individuals who have significant IRAs and do not need the income for retirement may wish to let their retirement accounts grow for the benefit of their beneficiaries. Such people may be good candidates for the Roth conversion. Although converting to a Roth IRA is taxable event, paying the taxes now on the Roth conversion will allow their beneficiaries to inherit the account without having to pay additional income taxes. Why would a client not convert? If your client is planning on retiring in the next 10 years, there may be no benefit from converting for the simple reason that the after-tax distributions to them (and their beneficiaries in the future) is less than the taxes they will have to pay at the time of the conversion. If retirement in imminent, your client may not realize the benefit of conversion. Others who may not benefit are those whose tax brackets will decrease in retirement, and of course, those who simply do not have the assets to pay the income tax upon conversion. In fact, if an individual does not have funds outside of the IRA to pay the tax, as a general rule, conversion is not likely to be a good idea. Roth IRA conversions can be a great opportunity, but conversions are not right for everyone. Contact Us: If you have any questions about the information in this Alert please contact any of the Offit Kurman Attorneys that you know or one of the editors below:  Steve Shane 443.738.1513 This newsletter is for informational purposes only and nothing herein is intended to be legal advice and will not create an attorney-client relationship between you and Offit Kurman, Attorneys At Law. While you are welcome to contact us by email, you are cautioned not to send any confidential information by email until an attorney-client relationship has been formally established.