National Association of Estate Planners and Councils

October, 2009 Newsletter
Provided by Leimberg Information Services

See other issues.

Scroggin on the Prospects for Estate Tax Legislation: A Smaller Exemption or a Return to 2001? A Con

LISI Estate Planning Newsletter #1505 took a close look at the seemingly never ending saga of the federal estate tax. Now, Jeff Scroggin weighs-in with his thoughts on this exceedingly complex issue.

John J. ("Jeff") Scroggin has practiced as a business, tax and estate planning attorney in Atlanta for over 30 years. Jeff serves as Founding Editor of the NAEPC Journal of Estate and Tax Planning and is a prior Co-Editor of Commerce Clearing House's Journal of Practical Estate Planning. Mr. Scroggin is the author of over 200 published articles and columns. Jeff is a nationally recognized speaker on estate, business and tax planning issues and has been quoted extensively, including in the Wall Street Journal (1999, 2004, 2005, 2006, 2007 & 2009), CHH Headline News, National Public Radio Marketplace Radio, National Public Radio Talk of the Town, Fortune Magazine, Forbes Magazine, Kiplinger's, Money Magazine, Worth Magazine, Financial Advisor, National Underwriter, Bloomberg Wealth Management, Smart Money Magazine, Journal of Financial Services Professionals, Wall Street Magazine, BNA Estates Gifts & Trusts Journal, Financial Planning, the New York Times, the Chicago Tribune, the South China Post, the LA Times, the Miami Herald and Newsday. Jeff is owner of one of the largest private collections of tax memorabilia in the US.

Here is Jeff's commentary:


The common consensus since 2001 has been that Congress would eventually adopt permanent transfer tax reforms that provide for estate tax exemptions in the range of $2.0-5.0 million and a flat estate tax between 25% to 45%.  Most recent commentators have espoused the view that by 2011 the estate exemption will be $3.5 million and the estate tax rate will be a flat 45%.

This article will discuss other possibilities, including the potential return to the 2001 transfer tax rules on January 1, 2011 – less than 16 months from now.

While not yet probable, there is an increasing possibility of no transfer tax reform passing Congress before 2011 – with the result that the transfer tax provisions of the 2001 tax act automatically expire on January 1, 2011. That possibility will grow in probability if 2010 drags on without transfer tax legislation being passed.

If permanent or temporary transfer tax rules are adopted in 2010, it is unlikely, in the face of huge and growing deficits, that Congress will approve a $3.5 million estate exemption ($7.0 million for a married couple).  A permanent estate exemption of $2.0 million for years 2011 and beyond may be the most we can reasonably hope for in legislation adopted in 2010.


When the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") was enacted, most estate planners (and probably most Republicans and quite a few Democrats) expected that Congress would enact some form of permanent transfer tax legislation before 2010 to replace the temporary transfer tax provisions of EGTRRA.  In the last 8 years, there have been numerous proposals advanced by both Democrats and Republicans, but none has come reasonably close to passing Congress. Both Congress in its 2010 budget and President Obama in his run for President have supported a $3.5 million exemption and a flat 45% estate tax bracket.

Unless legislative changes are enacted by the end of 2010, the 2001 EGTRRA changes to the transfer tax laws will expire on January 1, 2011.


You have to start this analysis with an old quote from Louse XIV's Controller-General of Finance: "The art of taxation consists in so plucking the goose as to obtain the largest amount of feathers with the least possible amount of hissing."  

Reform in 2009?

What is the chance of permanent transfer tax reform passing in 2009? Given the numerous legislative issues already before Congress in the next four months, it is extremely unlikely that it will address (or want to handle the conflict over) permanent transfer tax reform and the related issues, such as exemption portability. There are enough contentious issues before Congress (e.g., the economy, health care, the deficit, global warming, and the two wars) without having to debate the numerous proposals on transfer tax reform and their impact on federal revenue.

As noted in LISI Estate Planning Newsletter #1505 and articles in the Wall Street Journal (August 12, 2009) and National Underwriter (August 14, 2009), it appears that Congress will not address permanent transfer tax reform in 2009. Instead, it increasingly appears that Congress will carryover the 2009 rules to 2010, with the expectation that Congress will permanently address the issue in 2010.

Reform in 2010?

Thus, it seems logical that permanent transfer tax legislation, if any, will come in 2010. What are the chances of permanent transfer tax reform passing in 2010 at any significant exemption levels?

The Need. Let's start with an obvious truth: There is a dire need for new sources of federal revenue. The pressure to raise revenue is going to be intense in 2010 and the years thereafter:

  • The Congressional Budget Office and the White House agree that the ten year deficit will be over $9.0 trillion – greater than the total of all federal deficits since the country was created.  The Committee for Responsible Federal Budget ( released a statement after the August announcement of a $2.0 trillion increase in the deficit: "An updated CBO analysis of the President's budget would presumably provide even larger deficit projections than those released by the OMB." As we come out of recession, Congress will hear a growing chorus of demands to reduce the deficit. That means either spending cuts (which Congress has not shown much interest in) or raising taxes.
  • Most economists are predicting that the slow recovery from this recession will last at least through 2010. As a consequence, federal income taxes will not be recovering anytime soon and federal costs (e.g., unemployment, Medicaid, etc) will remain high.
  • The President has repeatedly indicated that it is his intent to cut the deficit in half in 2013. That promise cannot be met without significant broad based tax increases.
  • Projections on the 10 year cost of any final health care bill range from $600 billion to over $1.0 trillion.  Second only to the issue of a public option of health care insurance, the issue of how to pay for universal health care may be the most contentious aspect of health care reform.  In the near term, Congress is going to be looking for new sources of revenue. Could the estate tax be a ready revenue source? Or could increases in other revenue sources for health care dry up the well so much that the estate tax is one of the few untouched revenue sources still available?
  • The federal cost of reducing global warming remains largely unknown – at least until the terms of any final bill are understood.  Current proposals do not appear to be self-funding.
  • In August the President proposed extending the expanded Child Care Credit and Earned Income Credit (both which provide for refunds to Americans who pay no taxes) through 2019. The estimated cost of the proposal is $85 billion over the next decade.
  • The 2009 Annual Report from the Social Security Trustees (copy available at noted that the OASDI annual cost will exceed tax revenues in 2016. Although the trustees report $2.4 trillion in assets at the end of the 2008 fiscal year, most of the funds are held in US Treasury Securities, meaning that when the IOUs start coming due in 2016, the federal Treasury will have to start paying back the money. But even if the invested funds are fully repaid, the report notes that disability coverage will be "exhausted" in 2020 and the entire system will be "exhausted" by 2037. Reduced benefits and/or additional taxes will have to be obtained to cover these shortfalls.
  • Some experts report that the unfunded obligation for federal entitlement programs is more significant than most Americans realize.  David Walker, former head of the GAO stated in a Wall Street Journal article on September 6, 2009: "Our off balance sheet obligations associated with Social Security and Medicare put us in a $56 trillion financial hole—and that's before the recession was officially declared last year.
  • The Alternative Minimum Tax remains a thorn in the side of many Americans.  In an April 15, 2004 report, the CBO reported that 90% of American taxpayers with AGI between $100,000 and $500,000 would pay AMT in 2010. Temporary reforms have mitigated some of this impact, but the Tax Policy Center (report of February 1, 2007 available at has estimated that the cost of long term reform is $800 billion to $1.5 trillion. The Administration estimates that the 10 year cost of taking just middle and upper middle income taxpayers out of AMT would be $448 billion.
  • State budgets are in dire straits and there will be growing pressure on Congress to provide federal money to help support critical (and maybe not so critical) state programs.  The Tax Policy Center (report dated September 3, 2009 available at reports that in 2010, 48 states face budget deficits (only Montana and North Dakota were exceptions) and 36 states already anticipate deficits in 2011. The combined state deficits for 2010 and 2011 were projected to be at least $350 billion.

Taxes Will Go Up. There are a number of income tax increases that will automatically occur in 2011 (unless Congress eliminates these tax increases – an unlikely event): the increase in the top ordinary income tax rate to 39.6%, the increase of capital gains to 20% and the elimination of the 15% dividend rate.

Even with these automatic tax increases, to reduce the deficit and pay for new programs, Congress will have to find other significant revenue sources – and no single tax source will cover the entire shortfall.  There will be increases in income taxes at levels below $250,000 AGI. Social security taxes and capital gain taxes are probably going up. And estate taxes are going to increase.

The media has already noted that President Obama's promise to only raise income taxes on those earning over $250,000 in AGI (for married couples) is not going to make an appreciable dent in the projected $9.0 trillion deficit. An editorial in the New York Times on September 4, 2009, noted: "Nor is there enough to be gained by confining tax increases only to families making more than $250,000 a year ….. The question then is not whether taxes must go up, but when, how and how much." 

The Washington Post had a similar editorial on April 10, 2009 that said: "President Obama has promised that taxes will not be increased for families making under $250,000. That is a promise that will probably have to be dropped down the road." David Wessel in a column on September 3, 2009 in the Wall Street Journal estimated that the effective tax bracket on the "rich" would have to increase to 68.9% from the current 31.1% rate to pay the $9.0 trillion deficit.

Bottom line? Those earning $250,000 and above cannot solve this shortfall on their own. The revenue to reduce the looming deficit is going to have to include other sources of taxation.

Estate Tax Revenues. With so much of the focus on taxing the wealthy – how much could be raised from higher estate taxes?

  • A report by the Tax Policy Center (October 20, 2008 found at estimated that from 2008-2018, the current transfer tax laws (i.e., a return to 2001 in 2011) would generate $490 billion.  Making permanent the 2009 tax rules would reduce this revenue to $292 billion. Because this report included three years of larger exemptions (i.e., 2008-2010), it understates the total estate taxes which would be paid in the decade following 2010. Moreover, as baby boomers and their parents pass, the long term revenue from their massive wealth transfer could be even more significant.
  • If you Google the topic, you'll find projections of wider and generally higher ranges of estate tax revenue for the ten year period from 2011 through 2020.

There may be a less obvious part of this debate. Historically, estate taxes have been only 1-2% of the total federal revenue. But a study by Boston College researchers Paul Schervish and John Havens estimated that from 2000 to 2050, between $41 and 136 trillion will have passed. Even with a 20% recessionary reduction in household net worth, there is a significant amount of wealth getting ready to pass from one generation to the next. Could this massive wealth transfer help fund many of the revenue problems the country faces and will Congress consider this source to be a politically more acceptable way to reduce the huge federal deficit?

One of the pivotal concerns of any increased taxation in this recovering economy is the impact of increased taxes on the economic recovery. I have tried to find analytical comparisons of the macro-economic impact of higher taxes on income versus higher taxes on estates, but have not been successful. While it would seem that a dollar of income tax has a broader negative impact on the economy than a dollar of estate tax, without analytical support, I cannot make that argument. Hopefully, that study will surface in the future.

In any case, as revenue pressures build on Congress and the President, the estate tax is a relatively easy tax to impose, compared to breaking a promise of not taxing people above $250,000 AGI. Imposition of an estate tax at lower estate values will partially mitigate the need to raise taxes on those below $250,000. Besides, dead people tend to complain less than the live ones.

How Does Washington Respond? Clearly increases in income taxes on those below $250,000 AGI will be necessary. But the Obama Administration and the Congress will be loathe to break his promise to raise taxes on those below $250,000 right before a Congressional off-year election– remember the election impact of President Bush's statement that we read his lips on "No New Taxes?" Because of the 2010 Congressional election and minimizing the impact on an economic recovery, increased taxation of most taxpayers will probably have to wait until 2011.

As a result of immediate revenue needs, Congress and the President are and will be anxiously looking for new revenue sources that produce the least amount of taxpayer anger.  A 2009 poll conducted for the Tax Foundation provides interesting insights into how Americans view their tax system and where Congress might go to find more revenue (see the 2009 Tax Attitudes Study at

The above 2009 poll noted that over 2/3rds of participants believe the estate tax should be eliminated.  Despite the public's strong animosity to the estate tax, only a small number of Americans are actually subject to the tax (estimated to be less than 1% of all estates in 2009). Politically, the estate tax is an easier source of revenue than the imposition of a broader based income tax. If the choice is between taxing me or some other guy, I will always choose the other guy, even if I don't like the tax he has to pay.

It is important to remember that Congress does not have to do anything to have the 2001 transfer tax rules return in 2011. Despite what some pundits say, failing to adopt changes or allowing partisan conflict to purposely or unintentionally kill adoption of permanent reform is not going to be perceived in the same manner as adopting a tax increase. In today's partisan Congressional environment, failure to act can always be blamed on the uncompromising partisanship of the other side. In 2010, Senate Republicans (and some Senate Democrats) may push for a $3.5 million estate exemption, but the House Congressional leadership will push for a much lower exemption, with the increasing possibility that uncompromising gridlock occurs and no estate tax legislation passes.

While the Senate appears to be willing to agree to a higher estate exemption, the fight will probably come from the House, where there is stronger resistance to the idea of allowing up to $7.0 million (for a married couple) to easily escape the grasp of the tax collector.

The 2010 wild card: if Democrats become concerned about losing the House and/or Senate as November 2010 approaches and if the death tax opponents start gaining traction, Congress could adopt some sort of permanent or temporary (e.g., carry the 2009 rules through 2012) legislation in the late summer/early fall of next year.  However, there will be enough other issues demanding voter attention that permanent transfer tax reform may easily get lost in the noise and the Democrats may be more concerned about not ticking off their political base by giving those "rich people" another break.


Bottom Line?  It is all about what source of revenue raises "the least possible amount of hissing." In case you missed it, see the quote at the beginning of this section of the newsletter.

What are the chances of either a permanent or temporary extension of the 2009 $3.5 million estate tax exemption? With a post-recession Congress highly concerned (some might say desperate) about finding new revenue to reduce the deficit and fund new programs, how likely are they to adopt legislation that takes money off the table – either temporarily or permanently? If the Democrats intend to impose heavier income taxes on wealthier Americans, why would they seriously consider letting the children of wealthier Americans receive what many will consider a tax windfall by providing high estate tax exemptions? A permanent or temporary $3.5 exemption ($7.0 million for a married couple) would seem politically and economically unacceptable. But, I have to admit that political and economic realities have not always driven Congressional decisions.

While not yet probable, it is possible that the EGTRRA transfer tax rules will expire in 2011. This is an increasing possibility – which will grow in probability if 2010 drags on without transfer tax legislation being passed.

Equally or more possible is Congress adopting a permanent estate tax exemption which is somewhat larger than the $1.0 million exemption, while also adopting other changes designed to attack the benefit of current planning techniques, such as FLP valuation discounts.

A permanent estate exemption of $2.0 million may be the most we can reasonably hope for in 2010.

Scoring the Possibilities.  

In the spirit of the fall football season and with a sports commentator's dread (and probably with the same limited success) of trying to call it right, here are the author's best bets on transfer tax legislation:

Legislation in 2009:

·        Permanent Transfer Tax Legislation:  0%

·        Congress Temporarily Carries Forward the 2009 Tax Law for 2-5 years: 20%

·        One Year Carryover of the 2009 Tax Law to 2010: 80%

Legislation in 2010:

·        Nothing Passes, with an Automatic Return to 2001 in 2011: 40%

·        Permanent $2.0 million Estate Tax Exemption: 40%

·        Permanent $3.5 million Estate Tax Exemption: 10%

·        Permanent $5.0 million Estate Tax Exemption:   0%

·        Congress punts by extending the 2009 Rules a Few More Years: 10%

·        Elimination of the Step-Up in Basis: 0%

·        Elimination of Estate Taxes: 0%

The author sensibly declines any prognostication on the gift and GST exemption levels, reunification of estate and gift exemptions, the applicable transfer tax rates, portability of exemptions, restoration of the state death tax credit, inflation adjustments to exemptions, or any other changes. Any of these could get into or be traded away in any final legislation. The other big uncertainty: the impact of a 2010 Congressional election on the adoption of new tax rules in 2011.

Impact of a Return to 2001.

What happens if we return to the 2001transfer tax rules in 2011? There are a number of results, including:

Higher Taxes. Without the adoption of permanent legislation by the end of 2010, the payment of federal estate taxes will skyrocket on January 1, 2011. There are three different aspects of this increased taxation:

First, the estate tax exemption will drop from $3.5 million to $1.0 million.

Second, the flat 45% estate tax bracket will increase to 55% on estates over $3.0 million and 60% on estates over $10 million. Estates valued at over $10 million would pay an additional 5% surtax designed to eliminate the benefit of the marginal tax rates below 55%. The 5% surtax stops once the estate's value exceeded $17,184,000.

Last, the estate exemption and tax rates are not inflation adjusted - meaning that every dollar of growth in an estate will be subject to the highest applicable tax rate, even if the growth is solely the product of inflation. If many economists are correct and the deficit increases the inflation rate in the US, then this "bracket creep" could significantly increase estate taxes, even when the estate's inflation-adjusted value has remained stable.

Note the estate tax differences on the following estates, growing at an annual rate of 5%:

  2009 Estate 2009 Estate Tax 2011 Estate 2011 Estate Tax
Alternative #1 $2,000,000 -0- $2,205,000 $535,450
Alternative #2 $3,500,000 -0-  $3,858,750 $1,417,313
Alternative #3 $10,000,000 $2,925,000 $11,025,000 $5,410,000

Without being alarmist, it is important that clients understand the possibility of these significant increases in their estate taxes and that they be encouraged to plan for the reduction of these potential taxes now – not when any final legislation is adopted (or not adopted) in 2010. A "wait-and-see" attitude in not in the best interest of the client or his/her advisors.

As an aside, there has been some confusion about what the estate exemption will be in 2011. In 2001 the estate exemption was $675,000, but was being phased up to $1.0 million. At an annual growth rate of just over 3.64% (not much above inflation), the 2001 exemption of $675,000 will roughly equal the value of the $1.0 million exemption in 2011.  Effectively, we are close to the same inflation-adjusted estate exemption as we had in 2001.

Liquidity. If these higher taxes occur in 2011, they will create significant liquidity problems for many clients. Planners need to start raising the liquidity issues with clients today. If a client wants to purchase insurance to cover the potential increased taxes, they need to start planning today (e.g., the client becomes uninsurable before 2011).

Clients who decide to buy additional life insurance should consider placing the insurance in an irrevocable life insurance trust ("ILIT"). Because of the current legislative uncertainty, it may be appropriate to adopt contingency formulas in the ILIT to provide for how the passage of assets will occur in various scenarios. For example, if insurance is held in an ILIT, but is not needed to provide estate tax liquidity, a formula provision in the ILIT or the client's will could pass more assets to the donor's favorite charity. Flexibility should also include the use of limited powers of appointment in ILITs.

Many clients have estates in the range of $1.0 million to $3.0 million, including life insurance. Many planners have advised clients that with a federal estate tax exemption of $3.5 million each ($7.0 million collectively for a couple), they did not need to place life insurance in an ILIT, because the individual estate tax exemption and/or the joint exemption of the married couple produces a non-taxable estate. However, a return to a $1.0 million estate tax exemption could mean that many clients will have a taxable estate, with the result that 41%-55% of the insurance proceeds could be lost to federal estate taxes. Because of the three year contemplation of death rule on gratuitous transfers of life insurance, clients should consider making those transfers even before we know what legislation is adopted in 2010.

Retirement Planning. With the higher exemptions and new rules permitting heirs to make withdrawals from inherited IRAs over their lifetimes, many estate plans have provided that the retirement plan will pass to younger family members (to take advantage of the longer life expectancy) while passing other assets to a surviving spouse. These plans could create a number of problems upon a return to the 2001 rules.

For example, assume a client in a second marriage had a $1.5 million IRA and $2.0 million in other assets. Under his current planning, the IRA passes to a child from a prior marriage, while the $2.0 million is held in a QTIP trust for the second wife. At the current exemptions, no estate tax would be due at the client's death, assuming his spouse survives him. On the other hand, if the client dies after 2010, there could be a federal estate tax of approximately $210,000 on the transfer of the IRA to the child. If the child reaches into the IRA to pay the $210,000 in estate taxes, the child will create federal taxable income $210,000 and a federal income tax of up $83,160 (at a 39.6% federal rate). If the child then reaches back into the IRA to pay the income taxes, there is an additional income tax. Each tax-generated withdrawal from the IRA will incur a new income tax.

The reduction in 2011 of the available estate tax exemption and the increase in estate tax rates means that clients with significant retirement accounts will have to reconsider the impact of the imposition of both income taxes and estate taxes on these IRD (i.e., income in respect of a decedent) assets. In many cases, rather then lose over 50% of the retirement plan assets to estate and income taxes, the clients will choose to pass all or a portion of their retirement assets to charity.

This area is characterized by an interesting conflict. For years, Congress has been encouraging the growth and creditor protection of retirement plans, particularly for baby boomers. But an increase in estate taxes and income taxes on retirement assets in poorly planned estates after 2010 may create a tax windfall for the state and federal budgets.

State Death Taxes. Prior to EGTRRA, the federal estate tax was offset by a credit for state death taxes. Roughly 38 states used the amount of the credit as their state estate tax - these states effectively took a portion of the federal estate tax as their tax. In 2005, as part of EGTRRA, the state death tax credit was fully phased out and replaced with a deduction, effectively eliminating the estate tax in most states.

States were forced to either lose the revenue they had received from the credit or "decouple" from the federal estate tax and impose new state estate taxes. Today, roughly half the states have state estate taxes that are decoupled from the computation of the federal estate tax.

The return of the state estate tax credit in 2011 could create some confusion. In decoupled states which impose their own state estate tax, there will be confusion because state death taxes will not relate directly to the federal estate tax credit and tax computations. A number of decoupled states have lower estate exemptions than the federal exemption, creating a possible state death tax when there is no federal estate tax.  In some states, the combined state and federal estate taxes could exceed 60% because state estate taxes will exceed the federal state death tax credit.

Those states which have not enacted a new death tax (and which effectively lost any revenue from the estate tax in 2005), will suddenly see unexpected revenue. This change will effectively return dollars to the states that did not revoke their state statutes that coupled the state estate tax to the federal credit. For example, according to one source, Florida lost over $1.1 billion in revenue in 2006 from the elimination of the state estate tax credit. That lost revenue could now return to the state as an unexpected tax windfall.

Family Business Deduction. Planners and drafters of documents will have to deal with the return of the estate tax deduction for businesses that pass to family members. One of the more complicated pieces of federal estate tax, the deduction for qualified family-owned business interests ("QFOBI") could be restored in 2011, albeit at a total deduction of $300,000 per decedent. Clients with closely held businesses should make sure their estate plans contemplate the potential restoration of the QFOBI deduction.

Generation-Skipping Transfer Tax. EGTRRA tied the lifetime and estate GST exemption to the estate tax exemption. On January 1, 2011, the pre-EGTRRA GST exemption rules may return and the GST exemption could become $1.1 million, plus subsequent inflation adjustments.

Other Provisions. While most of us are vaguely aware of the major changes that comprised other parts of EGTRRA, there are some additional sun setting provisions that we may have forgotten about, including:

·                      The expanded estate tax exclusion for conservation easements.

·                      Liberalized rules for deferred payment of estate taxes.

·                      Rules governing automatic allocations of GST exemption to lifetime indirect skips.

·                      Retroactive allocations of GST exemption.

Flexible Planning. Planning from 2009-2011 is going to require not only flexibility, but also a continuous review of how the client's estate plan interacts with the changing estate and income tax rules. Flexibility is the key to planning in this chaotic environment.  Among the flexible approaches that need to be considered are:

The expanded use of limited powers of appointment. Such powers of appointment will permit changes in the estate plan to account for changes in the family and in the law.

Planning that considers the impact on asset allocations to family resulting from significant increases in the exemption through 2010, followed by a drastic reduction in 2011. For example, if the intent is to pass the estate tax exemption amount to children from a first marriage and the remainder of the estate to a spouse from a second marriage, the client must be advised on how the changing exemption amounts will affect the passage of assets to each of the client's heirs. Suppose a client in a second marriage has $5 million in assets. Does he want $2.0 million (2007-2008), $3.5 million (2009-2010), or $1.0 million (2011) to flow to children from a prior marriage? What amount is the surviving spouse expecting to receive?

Formula clauses that deal with various potential levels of estate and GST exemptions, depending on when the client dies. For example, in the above example, the client could create a formula that passes a set amount (e.g., $1.0 million) to his children, while any exemption amount in excess of the $1.0 million passes to a Bypass trust held solely for the benefit of the second spouse.

Plans that contemplate the use of disclaimers and Clayton QTIP marital trusts to maximize the tax avoidance possibilities in this unusual tax environment.

Finding creative ways to move appreciating assets out of estates that are expected to be taxable after 2010. Particularly for clients with estates between $2.0 million and $7.0 million, the combination of recession-depressed values, the lack of an inflation adjustment for the estate tax exemption and the increase in taxes as the estate grows can create an incentive to move appreciating assets out of the estate as early as possible.

If a wealthy client observes in 2010 that it appears the 2001 rules will return in 2011, the client should consider the tax planning technique of purposely paying gift tax, particularly when the gift tax rate in 2010 will only be 41-45%, while the estate tax rate in 2011 could top out at 60%.  Run the math of moving a recession-depressed asset out of the estate at this lower rate, combined with the benefit of removing the gift tax payment from the taxable estate (if the donor survives by 3 years).

Spouse Dying in 2009 or 2010. Given a possibility of higher estate taxes in 2011, planners should evaluate how to most effectively plan the estate of a spouse dying before 2011. Some of the approaches may include the following:

Make sure to use the full estate tax exemption of the first to die spouse. For example, assume an elderly couple has a $5.0 million combined estate and one of them is in poor health. Consider moving assets into the unhealthy spouse's estate before death. Suppose a client's wife is terminally ill, but owns no assets. In 2009, the client transfers $3.5 million in low-basis assets to the ill spouse, who revises her will to provide that those specific assets pass into a bypass trust. However, be careful of losing the step-up in basis pursuant to Code section 1014(e).

Having assets taxable in the estate of the first spouse to die could potentially reduce the top estate tax bracket, and remove future appreciation on those assets from being taxed at the higher rate for deaths after 2010. For example, assume a married couple has a combined estate of $15 million, with each spouse having $7.5 million in his or her estate. Both spouses are in their 80s and their assets grow at 5% per year. One of the clients dies in 2009, while the other dies in 2012. Purposely paying an estate tax in 2009 on the entire estate of the first spouse to die (i.e., eliminating any marital deduction) could save the family over $500,000.

Income Tax Planning. While the significant estate tax exemptions last and fewer estates are taxable or if higher exemptions become permanent, much of tax planning may shift to trying to avoid income taxes rather than estate taxes. For instance, instead of lowering the value of assets to reduce estate taxes, clients with estates below the available exemption may actually want to increase the value of assets to obtain a higher basis step-up at death.  The higher basis will reduce the income taxes paid by heirs on the sale of inherited assets and can create a higher basis for depreciable assets.

What Does This All Mean?

Whatever happens between now and January 1, 2011, virtually every estate plan will need to be reviewed in the next two years to examine the impact of the massive changes to both the income tax and transfer tax rules. For example:

Should higher income taxpayers convert to a ROTH IRA in 2010 to benefit their heirs, while electing out of paying the income taxes in 2011 and 2012 when their income tax brackets may be higher?

Should larger estates consider making taxable gifts in 2009 or 2010 when the overall gift tax rate is lower and recognizing that the gift tax is a tax exclusive tax (after three years)?

What is the impact on Bypass Trust planning when the estate tax exemption is changing each year, particularly for clients in second marriages?

Have the estate taxes been properly apportioned among the heirs?

Has the estate plan considered the impact of the increase in income taxes, capital gains taxes and dividend tax rates that occurs on January 1, 2011?

Does the estate plan properly account for the impact of state death taxes after 2010?

What is the impact on the computation of estate taxes of taxable gifts made before 2011?

Who benefits from this chaotic environment and the return of higher estate taxes? Seven groups will reap the greatest rewards:  The states that remain coupled to the federal estate tax state credit will receive an unexpected revenue boost. Charities will see increased estate contributions (particularly of IRD assets) to avoid the higher taxes. Fee-based planners who provide estate planning advice and estate attorneys will be inundated with work. CPAs will have more tax returns to file. The insurance industry should see substantial increases in life insurance sales to fund estate taxes. And politicians will see increased contributions to their campaigns from people on both sides of the debate. And the client/taxpayer? He'll be paying for all of it.


Jeff Scroggin


LISI Estate Planning Newsletter #1521 (September 17, 2009) at  Reproduction in Any Form or Forwarding to Any Person Prohibited – Without Express Permission.


2009 Tax Attitudes Study, found at;

Kaufman, "Estate Tax Legislation in 2009: Avoiding the Train Wreck," 36 ETPL 7 (July 2009); Zaritsky, "Estate Planning Implications of an Obama Presidency." 36 ETPL 1 (January 2009);  Scroggin, "Estate Planning to Cope With Legislative Uncertainty," 34 ETPL 10 (May 2007); Zaritsky, "Estate Planning While You Wait for Congress to Decide on Estate Tax Repeal," 32 ETPL 56 (June 2005);

Schervish and Havens, "Millionaires and the Millennium: New Estimates of the Forthcoming Wealth Transfer and the Prospects for the Golden Age of Philanthropy," Social Welfare Research Institute, Boston College, Boston, MA, October 1999.

Copyright © 2009 Jeff Scroggin All rights reserved.

All NAEPC-affiliated estate planning councils are eligible to receive a discounted subscription rate to the Leimberg LISI service. Please see more information about the offering. You may also contact your local council office / board member to find out whether they are offering the service as a member benefit.