Congressional Malpractice: Disastrous Formula Gifts, the Once and Future Estate Tax, and Dying (and Gifting) in Limbo


By: William C. Kalmbach

Congressional Malpractice.

1 If a taxpayer died December 31, 2009, with a taxable estate in excess of $3.5 million dollars, his or her executor has until September 31, 2010, to file with the Internal Revenue Service a United States Estate (and Generation Skipping Transfer) Tax Return and pay any tax shown to be due. If the executor fails timely to file such a return, he has breached a duty to the estate and can be held responsible for any penalties or interest imposed for a late filing. The Internal Revenue Service, a beloved part of the United States Government, is not a forgiving entity, and excuses such as the executor was too busy to file a return, or that two executors could not get along well enough to file a return, or that the executors will file a return and make it retroactive to the return’s due date will be met with a deficiency notice at best and handcuffs at worse.

So what are we to make of another beloved part of the United States Government, the Congress? On June 7, 2001, Congress enacted the Economic Growth and Tax Relief Reconciliation Act of 2001 (“EGTRRA”) and knew at that time that the Internal Revenue Code would repeal the estate tax for individuals dying in 2010, and then reimpose the pre-EGTRRA estate tax for those dying after 2010. Congress, therefore, had

eight and one-half years
to debate and enact a coherent set of laws governing death taxes. It could have repealed the estate tax – as the Republican Congress attempted and failed to do in 2006 – or it could have made the 2009 estate tax rules permanent – as the House of Representative voted to do in December of 2009 – but it did not. Instead, Congress has done nothing, missed its deadline, and thrown taxpayers and their planners into a confusing morass of no death tax, probably retroactive tax legislation, and a possible return to a credit exemption amount of only $1 million and a 55% rate of tax.

Disastrous Formula Gifts.
Worse than the confusion, some commonly drafted wills may, in the event of a decedent’s death in 2010, result in disastrous wealth transfer results, inadvertently disinheriting spouses in favor of children or children in favor of grandchildren. Consider a typical “credit shelter” will, which was designed to consume the credit exemption amount and pass the remainder of the estate to a QTIP trust for the surviving spouse. Such a will often devises and bequeaths to the credit shelter trust “that amount of assets which can pass free of the federal estate tax.” In 2010, an unlimited amount of assets can pass to the credit shelter trust, and, if the surviving spouse is not the beneficiary of that trust (and often he or she is not), the trust for the benefit of the children may receive the entire estate.

Similarly, some wealthy taxpayers write wills designed to consume their GST exemption at death, providing that grandchildren or a trust for their benefit receive “that amount of assets which fully consumes my remaining GST exemption amount.” In 2010, that amount is unlimited, and the specific bequest to grandchildren may consume the estate and leaving nothing for the residuary legatees, often the children, to whom the taxpayer desired to leave the bulk of the estate.

The Once and Future Estate Tax
. Compare for a moment the tax rates and exemptions from 2009 through 2011, as exist under current law. Such a comparison immediately suggests some courses of action on behalf of a savvy taxpayer.

YearGift Tax ExemptionTotal Gift and Estate TaxGST ExemptionMaximum Rate of Tax
2009$1 Million$3.5 Million$3.5 Million45%
2010$1 MillionUnlimitedUnlimited35%
2011$1 Million$1 Million$1 Million55%

A savvy taxpayer may want to die in 2010. Under currently law, no estate tax is due, however, legatees would generally receive the decedent’s assets with a carry-over basis, rather than step-up the basis of the assets to their date of death value, as was permitted prior to 2010. Carry over basis generally means the basis of inherited property remains the same as it was for the deceased owner; which potentially increases the amount of gain (and tax) when the property is sold. When property is inherited, the legatee can choose to take a step up in basis for only $1.3 million of the property. For any amount inherited over $1.3 million, the legatee’s basis will be the smaller of the deceased owner’s basis or the date of death market value. The basis of property passing to a surviving spouse can be increased by an additional $3 million.

A savvy taxpayer may also determine to make taxable gifts in 2010, particularly to grandchildren. With a maximum rate of 35% and no GST, there may never be a better time to make taxable gifts.

Dying (and Gifting) in Limbo.
Do we recommend dying or taxable gifting in 2010? Only for the brave of heart. Congressional leaders have stated that Congress will pass estate and gift tax legislation in 2010, and make such law retroactive to January 1, 2010. In other words, repeal will not have happened, and the law today is what Congress decides tomorrow. Questions exist as to whether such retroactivity would pass Constitutional muster. Although the United States Supreme Court has held that retroactive application of amendments to the estate tax do not violate the Due Process Clause of the Fifth Amendment, U.S. v. Carlton, 512 U.S. 26 (1994), the Supreme Court’s decision was decided by a differently-constituted Court, and the standard of review utilized (a tax statute’s retroactive application must be supported by a legitimate purpose furthered by rational means) almost guarantees that the executor of a wealthy decedent or a brave taxpayer who makes a substantial gift to grandchildren will challenge the law’s retroactivity, and, like the executor in U.S. v. Carlton, after nine years of litigation, we may know the answer.

Hold on; it’s going to be a bumpy ride.


1Please note that the opinions expressed herein are those of the primary author of this letter, William C. Kalmbach; other members of Cook, Yancey may think Congress is doing a dandy job