Because of the federal estate tax repeal for year 2010, people dying in 2010 may pass all of their estate to their loved ones without estate tax liability. Repeal came with a shift of taxes from estate tax born by the decedent’s estate to the beneficiaries through income tax and capital gains tax because there is a limitation of the step-up basis at date of death and the spousal basis adjustment. In some cases all of the estate will pass to the surviving spouse and in some cases all of the estate will go to the children. The difference will depend on whether there is a will or trust and its funding formula.
Most “non-taxable” estates (so characterized based on years up to and including 2009), will pass in 2010 to the surviving spouse or to the children, if there is no surviving spouse. In taxable estates (based on previous years), estate planners minimized the estate tax due by a formula which allocated to the family trust (also known as by-pass trust or credit shelter trust) the amount which could pass without federal estate tax (in 2009 that amount was $3,500,000). The excess amount was allocated by formula either outright to the surviving spouse (usually in first marriages) or to the marital trust (in a QTIP usually in second marriages).
If these tax sensitive wills and trusts were not amended to limit the allocation to the family trust, if death occurs in 2010 that will result in overfunding the family trust which could have the result of disinheriting the surviving spouse. Even if there are sufficient assets and income for the use and benefit of the surviving spouse, overfunding the family trust will result in the loss of the $3.0 million spousal basis adjustment.
Repeal of federal estate tax does not affect the estate/inheritance tax imposed by many states including Oregon ($1,000,000) and Washington ($2,000,000). Those estates which exceed these amounts if death occurs in 2010 will pay estate tax on the excess to those states where there is an overfunded family trust.
What to do? The first thing to do is to review your estate plan. Once you have done that, here is a list of other things to consider with your counsel:
- Call your estate planning attorney to discuss the specifics of your situation. You may find everything is fine. Or you may be told that you have an overfunded family trust.
- In the overfunded family trust situation, your attorney may advise you to amend your will or trust to limit the amount that is allocated to that trust for the year 2010.
- To avoid the potential of losing the spousal basis adjustment, consider transferring assets from the wealthier spouse to the poorer spouse to “save” that adjustment.
- To prepare for the possibility of paying state estate/inheritance tax, consider a 1 year term insurance for the expected tax liability.
To emphasize, any action taken should be taken with the advice and assistance of competent estate planning counsel. This is a very technical area of the law which requires the services of an expert.