Planning for the Unthinkable... Revival of the Estate Tax

 Since 2002, estate planning attorneys have been discussing the estate tax repeal, the phase out through 2010 and the "sunset" provisions that would bring back the old tax laws in 2011. In most all conversations it was considered unthinkable that Congress would not fix the estate tax laws to match the system that was in place during the repeal period with a unified tax credit of $3,500,000.00 t0 $5,000,000.00. In fact it was unthinkable that the laws would not be revised before 2010 due to the accounting nightmare that results from a single year with a vastly different tax system. At the time of this blog post, Congress has two months left to fix this issue.

For some background, the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA"), phased out the estate tax with the goal of repeal in 2010. The phase out was implemented by dropping the tax rate (reducing the top rate from 55% to 45%) and increasing the unified credit from 2002 through 2009 (from $1M to $3.5M). Due to budgetary issues, the "repeal" had to expire by 2010. Prior to EGTRRA the federal estate tax topped out at a 60% rate and would have phased up to a $1,000,000.00 unified credit. Failure of Congress to act will bring back the 60% tax rate and the lower unified credit amount.

Estate planning attorneys commonly use credit shelter trusts to allow a married couple to each take advantage of their unified credit essentially doubling the amount of assets that can pass to the next generation free of estate tax. The credit shelter trust allows for the estate of the first deceased spouse to split its assets and put a portion in a trust that preserves the first deceased spouse's credit. Then at the death of the surviving spouse, the credit shelter trust does not count in determining the surviving spouse's assets allowing the surviving spouse's credit to be applied elsewhere.

A failure to revise the estate tax has a number of problems the primary of which is that the tax will affect more estates than originally intended. It is common that a young family with children would have life insurance in excess of $1Million due to the current cost of living and what might be needed for the support of their children. For the purposes of an example, let's assume the $1 Million life insurance pushes the value of the couple's estate to $1.5 Million. Now to avoid hundreds of thousands in estate taxes, this family needs to invest in a credit shelter trust when all they have done is purchase a reasonable amount of life insurance.

With the current uncertainty we prefer to give our Clients the information on the estate tax and let them decide whether they think the extra expense of a credit shelter trust is justified. As we come down to the deadline, it appears that the added expense may become necessary. We hope that Congress acts soon to provide clarity on this issue but if the last eight years have been any example, the unthinkable will probably occur.