Originally published in the Journal of Financial Planning, January 2010.

When the Economic Growth and Tax Relief and Reconciliation Act of 2001 ("EGTRRA"), was signed into law back in the summer of 2001, almost no one seriously thought that the law would ever be given its full effect – that is, the ultimate repeal of the federal estate and generation-skipping transfer taxes on January 1, 2010. However, through Congressional inaction for almost eight and a half years, the federal estate and generation-skipping transfer taxes are, indeed, no more . . . at least until January 1, 2011, when due to the "sunset" of EGTRRA they are scheduled to be reinstated with a mere $1 million exemption and a top rate of 55%. Notwithstanding repeal of the federal estate and generation-skipping transfer taxes, however, the federal gift tax remains in effect in 2010, with a $1 million exemption and a top rate of 35% (down from 45% in 2009). Furthermore, state level estate, gift and generation-skipping transfer taxes remain unchanged.

Moreover, the repeal of the federal estate tax comes at a price – the income tax basis of inherited property is no longer "stepped up" to the property's date of death value. Instead, a new "carry over" basis regime means that appreciated property acquired from a decedent will continue to have the decedent's adjusted basis. Thus, many inheritances will now be subject to capital gains taxes. Fortunately, the new law permits an executor to allocate up to $1.3 million to increase the basis of any estate assets, and an additional $3 million to increase the basis of assets passing outright or in trust to a surviving spouse.

In light of the foregoing, is there some action that you should be taking to make sure that your estate planning documents carry out your objectives? Absolutely, and here are some recommendations...

REVIEW YOUR LAST WILL AND TESTAMENT OR REVOCABLE LIVING TRUST AGREEMENT

Although no two wills or revocable trusts are exactly the same, many serve to minimize or even negate estate and generation-skipping transfer taxes by utilizing formula clauses to take full advantage of the estate and generation-skipping transfer tax exemptions no matter what the dollar amount at which the government has them set. In other words, a formula clause obviates the need to change your documents every time the exemption amount changes, and when you consider that since 1997 the estate tax exemption, for example, has changed seven times, the benefit of a formula clause becomes clear.

Now that the federal estate and generation-skipping transfer taxes have been at least temporarily repealed, however, many formulas will not work as intended. For example, nothing may pass to a surviving spouse if the exemption amount is structured to pass to certain types of credit shelter trusts (or outright to the children) and the exemption amount is defined by formula as "the maximum amount that can pass free of federal estate tax" (or language of similar import). Other wills provide for a formula based on the "optimum marital deduction" and it is not clear how such a formula will now be construed since there is no longer a marital deduction under the law.

Separately, taxpayers who are resident in a state that has a state estate tax (for example, New York, New Jersey and Connecticut), may have significant state estate taxes under such a formula that could otherwise have been avoided. Nevertheless, we believe that for many clients it may actually make sense to pay state estate taxes now in order to avoid future federal estate taxes if, in fact, the federal estate tax is later reinstated. Of course, whether paying state estate taxes now makes sense for you depends upon your particular situation.

In addition, certain clients with significantly appreciated assets should consider the impact of carry over basis to ensure that, if available, property with at least $3 million of unrecognized gain (and not simply $3 million in value of property), passes to or in trust for the surviving spouse. In other cases, however, passing too much property to the surviving spouse in order to enable the allocation of every last dollar of available basis adjustment may cause additional estate tax to be due at the subsequent death of the surviving spouse if the federal estate tax is later reinstated. Therefore, this issue must be carefully considered on a case by case basis. And, in order to ensure full flexibility to allocate basis increases in the most appropriate manner, the authority of the executor or personal representative must be broadly defined in the will.

The "Take Away": Carefully review the terms of your estate planning documents to determine whether any formula clause issues exist and, if so, how they might best be resolved for your specific situation. In addition, your executor should be given authority to allocate basis adjustments as may be most appropriate to save overall taxes.

CREATE A MARITAL TRUST FOR YOUR SURVIVING SPOUSE INSTEAD OF AN OUTRIGHT BEQUEST

Many people choose to provide for their surviving spouse via an outright marital share of the estate in lieu of a gift to a marital trust because either qualifies for the unlimited marital deduction from estate tax but the outright bequest is sometimes considered less burdensome on the surviving spouse than a marital trust. However, even for those who have not yet found the many non-tax benefits (i.e., asset protection), of a marital trust compelling, the current state of uncertainty in the tax law provides a potential tax benefit for the marital trust.

This is because a marital trust will generally only be taxed as a part of the surviving spouse's estate if an election was made on the deceased spouse's estate tax return to qualify it for the unlimited marital deduction. Absent such an election, the deceased spouse's estate will not get a marital deduction (meaning that the marital trust property will be taxed as a part of the deceased spouse's estate), and the marital trust generally will not be taxed as a part of the surviving spouse's estate when the surviving spouse later dies. In contrast, an outright bequest to the surviving spouse automatically qualifies for the unlimited marital deduction, but will also automatically be taxed as a part of the surviving spouse's estate.

Thus, with a marital trust the executor has flexibility to minimize estate taxes depending on the circumstances. For example, if the federal estate tax has been reinstated on or before the death of the first spouse to die, an election can be made to negate immediate federal estate tax (at the cost of causing the trust to be taxed as a part of the surviving spouse's estate when the surviving spouse later dies). If instead, there is no federal estate tax in effect at the death of the first spouse to die, no election need (or perhaps even could) be made. And, absent the election, the marital trust should not be taxed as a part of the surviving spouse's estate if the federal estate tax is later reinstated before the surviving spouse's death.

The "Take Away": If you are married, and if your will or revocable trust agreement currently provides for an outright bequest to your spouse, you should consider having the document revised to provide for a marital trust.

CONSIDER WHETHER MORE PROACTIVE PLANNING IS WARRANTED

Even though the federal estate and gift taxes were (historically) imposed at the same rate, the federal gift tax was effectively less expensive than the federal estate tax. This was because the federal estate tax was imposed on a "tax inclusive basis" and the federal gift tax was imposed on a "tax exclusive basis."

For 2010, the gift tax is imposed at a reduced rate of only 35%. Thus, the tax benefit of making a taxable gift is even greater - assuming, of course, that the federal estate tax is later reinstated with a rate in excess of 35% (and that some higher gift tax rate is not later enacted with retroactive effect). In addition, New York and New Jersey do not impose a gift tax, thus making lifetime gifts even more attractive for residents of those states.

Separately, since there is no longer any federal generation-skipping transfer tax, absent a future retroactive enactment of the tax, donors no longer need to feel constrained in making gifts only to children. Instead, unlimited amounts might be gifted, either outright or in trust, to grandchildren or more remote descendants free of generation-skipping transfer tax. And, if you already have a trust for your children and grandchildren, it might now be appropriate to make distributions out of the trust for the benefit of grandchildren while there is no additional generation-skipping transfer tax to be imposed on such distributions.

It is not clear at present, however, what impact a retroactive reinstatement of the generationskipping transfer tax or 45% tax rate would have on prior made gifts. There are, however, planning strategies available which may serve to minimize or negate any unintended consequences.

The "Take Away": If it is feasible for you to make substantial gifts, you should give careful consideration to making such gifts this year, and to doing so as early as possible this year.

CONCLUSION

Although almost no one seriously thought that EGTRRA's repeal of the federal estate and generation-skipping transfer taxes would ever be allowed to come into effect, the New Year heralded their repeal and that fact must now be addressed in almost every estate plan. Please feel free to contact any one of the attorneys listed below to schedule a review of your specific situation to ensure that your estate planning documents continue to serve your objectives, and to discuss planning opportunities under the new law.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.