Estate and Gift Tax Alert
March 2010

To Our Clients, Friends and Colleagues:

The U.S. Estate and Gift Tax system is in a major state of flux. We offer you a few insights and suggestions regarding the status of Estate and Gift Tax for 2010 and looking forward. We encourage you to review your current estate plan to ensure that your intentions will still be met regardless of the current tax law instability.

Recapping Estate Taxes - 2009, 2010 and Beyond

In 2009, the effective exemptions against estate and generation-skipping transfer (GST) taxes were set at $3.5 million. Estates exceeding the exemption amount were subject to a maximum 45% tax rate.

In 2010, the estate and GST taxes have been repealed so there is neither an estate nor GST tax resulting from transfers of property as a result of death (unless new legislation is retroactively applied). Gift taxes are still in effect in 2010, the top rate of tax being reduced this year to 35% from 45% (which applied to gifts in 2009).

In 2011 and thereafter, estate and GST taxes are scheduled to return at higher rates with lower available exemptions than 2009. In 2011 and beyond, estate and GST tax exemptions will be reduced to a mere $1.0 million and the top tax rate will be 55%.

Many Washington insiders believe Congress will pass estate and gift tax legislation that applies retroactively to January 1, 2010. While this may seem unconstitutional, prior retroactive tax laws have been upheld by the U.S. Supreme Court.

These uncertain times clearly provide challenges for individuals attempting to plan their estates. We will certainly do all we can to keep you fully informed of any changes that occur to the estate and gift tax laws over the next year. In the interim, we have set forth below a very brief summary of some of the issues the current tax laws have created.

Why You Should Be Concerned

The 2010 estate tax repeal causes concern for clients whose estate plan includes formulas to determine what portion of a person’s estate will pass to different trusts or individuals based on the amount that could pass free of estate tax. For example, the estate plan of many married couples divides their estate into two or three sub-trusts on the death of the first spouse. One sub-trust is equal to the deceased spouse’s unused estate tax exemption amount. Another sub-trust is equal to the deceased spouse’s “optimum” marital deduction. Neither sub-trust will be subject to estate tax when the first spouse dies even if there is an estate tax. The estate tax exemption sub-trust (sometimes called the “credit shelter” or “bypass” trust) escapes tax because it takes advantage of the estate tax exemption of the first spouse to die. The estate tax exemption sub-trust also escapes estate tax when the surviving spouse dies. The optimum marital deduction sub-trust (sometimes called the “marital” or “QTIP” trust) can defer estate tax until the second spouse dies. This is the most common estate plan for married couples to dispose of their wealth and minimize estate taxes.

While the formula clause, as previously drafted, may be appropriate for many clients, it can have disastrous effects for some clients in 2010. For example, some estate plans are drafted to leave the estate tax exemption amount to children on the first spouse’s death, rather than held for the surviving spouse. This could result in no assets being allocated to the surviving spouse under the marital deduction trust due to the elimination of estate and GST taxes in 2010. We strongly recommend that you review your estate plans with this office to be sure you are not caught in a situation in which your estate plan does not accomplish your goals.

Other significant changes accompanying the estate tax repeal are also effective in 2010. The previous date of death income tax basis adjustment is eliminated on amounts in excess of $1,300,000 (plus an additional $3,000,000 on bequests to spouses). Although no federal estate tax will be imposed by the federal government in 2010, inherited assets with capital gains in excess of $1,300,000 (plus an additional $3,000,000 for assets passing to spouses) may be subject to capital gains tax upon their subsequent sale, since they will be required to assume a modified carryover basis (i.e., the basis the decedent has in the assets plus the basis adjustment discussed above). The negative impact of carryover basis will affect many more families than the federal estate tax repeal. Furthermore, very few, if any, estate planning documents executed before January 1, 2010, address how this limited step-up in tax basis should be allocated among a decedent’s assets.

Federal Gift Tax

The amount that an individual can gift free of federal gift tax remains the same in 2010. The annual exclusion is $13,000 per donee, or $26,000 if both spouses agree to the gift. Similarly, the lifetime gift tax exemption remains $1,000,000. Beginning January 1, 2010, however, the maximum gift tax rate dropped from 45% to 35%. Clients may want to make taxable gifts in 2010 to take advantage of the lower 35% gift tax rate; however, there is a risk Congress will retroactively reinstate the 45% rate. In addition, if Congress acts to permanently repeal the federal estate tax, any gift tax paid may prove to have been unnecessary.

Planning Opportunities

Clients with interests in businesses will still need to create business succession plans, while considering the associated tax consequences. Clients with relatively large retirement plans should consider converting at least a small portion of such plans to Roth IRA's. Clients who own homes or other real estate outside of California will still need to factor this complexity into the planning process. It will still be critical to plan for non-U.S. citizens and their spouses.

What Action Should You Take?

What action you should take will depend on your individual circumstances. We believe it is prudent to meet with our clients to review their existing estate plans as soon as possible in order to determine what changes, if any, should be made in light of the current tax environment. We look forward to hearing from you and meeting with you to review your estate plan. Please call us at your earliest convenience.

Very truly yours,

Barulich Dugoni Law Group, Inc.


Paul J. Barulich, Managing Partner