Effective January 1, 2010, the Federal Estate Tax has been eliminated for people dying in 2010. While the Federal Estate Tax laws in 2009 only affected estates over $3.5 million for individuals or $7 million for couples, the repeal of the Federal Estate Tax laws in 2010 will result in higher capital gains consequences for much smaller estates.

When the Federal Estate Tax law was in effect, the assets of an estate would receive a step-up in the tax basis on property owned by a decedent based upon the date of death value, whether or not any estate taxes were owed. Under the current law, this step-up is limited to the first $1.3 million of assets for bequests made to people other than a spouse and the first $3 million for assets passing to a surviving spouse. This creates a greater burden for the executor unless a Will is clear as to how assets are to be distributed, as the executor now needs to not only determine the allocation of assets but also which of those assets will be allocated the step-up in tax basis. Additionally, the executor must determine the tax basis of all the assets of the estate. This may prove to be very difficult, especially for those estates in which a decedent held stock or other assets for many years. The IRS has clarified that an heir’s basis will be zero unless the heir can provide proof as to how the tax basis was determined.

Unless Congress acts prior to the end of the year, on January 1, 2011 the estate tax law will revert back to the way it existed in 2001 and a Federal Estate Tax will return into being with a higher 55% tax rate and an effect on Estates as small as $1 million. Many Estate planners continue to believe that Congress will enact changes to avoid the Estate Tax being revived in 2011 with higher rates and lower limits. We will of course keep you advised as events develop.

The Internal Revenue Service has also announced that the Annual Gift Tax exclusion will be maintained at its current $13,000.00 per year per person level for the year 2010. This means that in 2010, each person can continue to give the sum of $13,000.00 to as many people as they want without incurring any gift tax. A married couple can give up to $26,000.00 per recipient. The current rules regarding tuition and medical expenses continue. This means that in addition to the $13,000.00, payments of tuition paid directly to an educational institution and payments of medical expenses paid directly to the provider of services are not considered taxable gifts.

Questions? Visit our Probate, Estate Planning or  Estate Administration Pages, or email us at gwmain@gwlaw.com.

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Not only is it important to review your estate plan for probate purposes on a regular basis and to consider any new additions to your family, the acquisition or disposition of property, or the loss of a loved one, it is equally important to consider the current fiscal climate when evaluating new and re-evaluating existing estate planning opportunities.

Those of our readers who have recently secured a mortgage or refinanced their homes may have noticed that interest rates are rising. Although this obviously makes borrowing more expensive, it also brings about new estate planning opportunities.

Rising interest rates, in particular, make two estate planning strategies very attractive: the qualified personal residence trust (“QPRT”) and the charitable remainder trust (“CRT”). This article will focus on QPRTs and we will highlight the benefits of rising interest rates on CRTs in a future newsletter issue. By way of background, the IRS utilizes interest rates to determine the present value of assets placed in a trust. The benchmark is the applicable federal rate (“AFR”) which is tied to the prevailing Federal Reserve interest rate which generally changes each month.

A personal residence or second home/vacation home is often the most valuable and highly appreciated asset in your estate. A QPRT allows the property owner to move that home into a trust but still retain a proprietary use of the residence for a preset number of years. When the trust period finally ends, the home is passed on to the trust beneficiary. When the property owner creates the QPRT, he or she has made a present taxable gift to the beneficiary. But the taxable value of the gift is reduced by the owner’s right to continue using the residence through the life of the trust. The present value of the gift is determined by the prevailing AFR at the time when the trust is established and by the length of the trust. The higher the interest rate and the longer the term of the trust, the lower the present value of the gift.

For example, suppose a 65-year-old grandmother has a $1,000,000 vacation home. If she were to put that home into a QPRT for a 10 year term at a time when the AFR was 4.6 percent, the IRS would determine the value of the final gift to her heirs to be worth $483,000. If the prevailing AFR was 6.5 percent, then the present value of the final gift to her heirs is reduced to approximately $400,000. In that case, Grandma has an additional $83,000 to use toward her $1,000,000 lifetime gift tax credit. In addition, the value of the house is locked for gift tax purposes. Therefore, any appreciation in the value of the house after it is transferred to the QPRT is not subject to gift tax.

The problem is that, for the QPRT to be worthwhile, Grandma must outlive the QPRT. If she dies before the QPRT terminates, the full value of the house is included in her estate. Effectively, it is as if no gift had been made. On the other hand, in the event she outlives the QPRT and wants to continue using the house after the trust concludes, she can simply rent it from the heirs.

If you own your residence or a vacation home, a properly drafted and executed qualified personal residence trust may eliminate federal estate tax and minimize federal gift tax on that asset as described above. We welcome the opportunity to discuss how this estate planning technique might apply to your situation, and assist with any probate issues you may have.

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