The Federal Estate Tax Returns In 2011: What Is Congress Going To Do?

Well, 2011 is less than four months away, and Congress has not passed any reforms to the 2011 Federal Estate Tax. As you know from previous newsletters, in 2001 Congress passed the Economic Growth and Tax Relief Reconciliation Act of 2001 ("EGTRRA") that gradually raised the federal estate tax exemption from $675,000 in 2001 to $3.5 million in 2009 and dropped the estate tax rate from 55% in 2001 to 40% in 2009. In 2010, EGTRRA abolished the federal estate tax altogether and replaced the lost tax revenue by eliminating the stepped-up basis for capital gains on assets transferred upon death. However, in 2011, the federal estate tax will return with an inflationary adjusted exemption level of approximately $1 million and a tax rate of 55%.

Many people on the right of the political spectrum are not happy with the return of a lower exemption and higher rates and want a return to 2009 or a continuation of the 2010 rules. A group on the left are unhappy with what is viewed as the wealthy not paying any federal estate tax. They want a retroactive estate tax applied back to anyone with a taxable estate that has died in 2010. Needless to say, because of these two issues, along with the political antics of both political parties, there is a high level of indecisiveness in the estate planning community on where the 2011 Federal Estate Tax is going.

The uncertainty has slowly creeped into in the general public's awareness to the point that I thought laying out the suggested plans would be a good idea. I will not address the retroactivity aspect for 2010 because it will quickly drift into high level Constitutional law. Moreover, I think retroactivity is unlikely to happen. It is way too late in the calendar year as the first estate tax forms are due to the IRS in a few weeks. Second, there are several billionaires that died this year and their personal representatives would have large war chests to fight any retroactivity through litigation.

There are approximately 40 different bills sitting in either chamber of Congress that address the federal estate tax in some form or other. Some of the bills have no shot of passing like H.R. 205 Death Tax Repeal Act, even though it has 92 co-signers because of financial reality. Other bills have very few co-signers, or are just slight derivatives on other bills. I think there are four real proposals on the table that have the most momentum and support, though, when dealing with Congress, anything can happen, and it could all change. The four proposals are: the Obama proposal, the Lincoln/Kyl proposal, the Harkin/Sanders proposal, and the Do-Nothing proposal.

The basics of the Obama proposal would include:

  • Creating a $3.5 million exemption that is not indexed for inflation
  • Having a top rate of 45% for both the estate and gift taxes
  • Continuing the gift tax and the generation skipping transfer tax
  • Repealing the state death tax credit in favor of the estate tax deduction
  • Repealing the qualified family-owned business deduction
  • Having no portability or unified credit aspects
  • Requiring a 10-year period for Grantor Retained Annuity Trusts ("GRATS")

The analysis of this bill is pretty simple. It maintains many of the same aspects of EGTRAA like the $3.5 million exemption level and tax rate, but would be particularly nasty in what the government is eliminating to pay for the program under its PAYGO rules. In this case, the Obama proposal is eliminating the tax credit an estate receives on its federal estate tax payment due to payment of state estate taxes and replacing it with a deduction. A credit is always better than a deduction because it comes right off the top, while a deduction is based on the tax rate. The Obama proposal also extends out GRATS to ten years and repeals the qualified family-owned business deduction.

The basics of the Lincoln/Kyl proposal would include:

  • Setting the estate tax rate at 35 percent, phasing it in over 10 years
  • Having a $3.5 million exemption amount, eventually rising to $5 million in 2020 and indexed for inflation thereafter
  • Providing a "stepped up basis" for inherited assets
  • Including an alternative election for 2010 that would allow deceased taxpayers to either retain this year's estate tax rate (0%) together with "carry over basis" (as opposed to "stepped up basis") or file under the provisions of the new bill using the new rate (35%) together with "stepped up basis."

From a simple glance, it looks like this bill would follow along the trajectory of EGTRRA by continuing to raise the exemption and lower the tax rate for the federal estate tax until the year 2020. The main issue with the Lincoln/Kyl proposal is that it would generate less revenue than the Obama proposal, and there would be a need to make up the difference in some form under PAYGO rules. Senators Lincoln or Kyl have not addressed that issue to this point. The bill would also provide a quasi-retroactivity to capture some of the lost estate tax due in 2010, but it would be based on the personal representative's option that best suit the estate.

Early this summer it appeared that Senators Lincoln and Kyl had enough other Senators on board that they asked the Senate Finance Committee to amend H.R. 5297 --Small Business Lending Fund Act of 2010 bill, to incorporate the federal estate tax issue into H.R. 5297. However, it never gained much traction. Since then, the Small Business Lending Bill has under gone huge changes, and it is unlikely to include the federal estate tax issue.

The basics of the Harkin/Sanders proposal would include:

  • Having a progressive tax rate based on estate size structured as:
    • For estates between $3.5M and $10M would be taxed at 45%
    • For estates between $10M and $50M would be taxed at 50%
    • For estates above $50M would be taxed at 55%
    • For estates above $500M there would be a 10% surtax on the 55% rate
  • Protecting family farmers by allowing them to lower the value of their farmland for estate tax purposes by up to $3 million and indexed for inflation
  • Being retroactive to the beginning of 2010
  • Closing loopholes including:
    • requiring consistent valuation for transfer and income tax purposes
    • modifying the rules on valuation discounts
    • requiring 10-year minimum term for (GRATS)

The basis of the Harkin/Sanders proposal was the death of George Steinbrenner and other billionaires that could pass their assets, estate tax free, in 2010. It is the most progressive bill given its staggered tax rate based on estate size. I will say it is also the most confiscatory of the approaches. A tax rate of 65% percent on estate above $500 million is pretty harsh. The likely consequence is that someone with $500 million in the bank will change citizenry from the United States to another country where they already have a home to avoid the 65% tax rate.

The Do-Nothing proposal would make no changes, and the 2011 provisions of EGTRRA would come into effect on January 1, 2011. The Do-Nothing proposal would re-introduce the federal exemption rate at approximately $1 million and institute a tax rate of 55% on estates over that amount.

So where do we stand right now? It is all about politics and whether either side is willing to compromise to get a deal done. The conventional wisdom is that Congress will address the issue after the elections; however, I am not so sure. Most estate planning attorneys felt Congress would not let the federal estate tax disappear in 2010, but it did happen. My feeling is that it is very easy, politically, to let the Do-Nothing proposal to occur. Then both parties can use that as a fund raising issue and also point to the other party as the reason for EGTRRA's 2011 bite.

Finally, to answer the question I posed in the title of this article: unequivocally, yes, the federal estate tax is coming back in some form in 2011. With Congress in gridlock right now over the election, the Do Nothing proposal becomes more likely with each passing day. Sadly, as I noted last month, people with small estates will be scooped up in the mess and pay thousands of dollars in taxes they shouldn't if Congress addressed the issue.

Basics of Estate Planning: Advanced Medical Directives

Most people understand how important a will or a trust is and how it relates to their death. They might not have a will in place but they understand how it controls their property after death. What many people fail to appreciate is that planning for his or her incapacity, through a Durable Power of Attorney ("DPOA") and/or an Advance Medical Directive ("AMD"), might be even more important. In this month's Basics article, I want to specifically address AMD's as a tie-in to September's Estate of the Month and will provide more information on DPOA's in a later newsletter.

Why would an AMD be more important than a will or trust? It is pretty simple. For a will to take effect, you have to be dead. Your loved ones might be impacted by a poorly planned estate, but nothing worse is going to happen to you. An AMD will take effect when you are still alive but can not indicate your wishes with respect to medical care. A poorly drafted AMD, or one that gives the wrong person power, might result in your death or being subject to an unwanted treatment

But let's take step back and explain. According to the Virginia Department for the Aging, an AMD allows you to state what level of medical care you want if you are unable to make decisions for yourself. Specifically, you can direct that a specific procedure or treatment be provided, such as artificially administered hydration (fluids) or nutrition (feeding); direct that a specific procedure or treatment be withheld; and/or appoint a person to act as your agent in making health care decisions for you, if it is determined that you are unable to make health care decisions for yourself. In short, it says what medical care you do or do not want and possibly appoints someone to make medical decisions, if you are unable to make them.

Your life will be in the hands of another person of your choice because, by appointing that person your agent, that person has decision-making priority over any other individuals who could, by law, make health care decisions for you. It essential that the person you appoint as your agent understands what level of care you would want if you are unable to speak for yourself. Most people appoint their spouse as their agent and have had some level of discussion on medical care. However, a single older client might be relying on a friend or relative to act as an agent, where an in-depth conversation has not occurred. The agent might make the wrong decision on medical care, resulting in withholding treatment that was wanted or applying treatment that is unwanted.

The agent also has to be a person that can be trusted. There are certainly horror stories of people placing faith in an agent that has a financial gain arising from the person dying. That seems heartless, but there are stories of an agent pulling the plug when it would likely have been against the wishes of the patient.

As for powers that a person can give their agent, most states have guidelines with respect to AMDs. The guidelines give the basic types of procedures and treatments that a person would either want done to them or not done. However, they are only guidelines, and a client can draft an AMD to address almost any hypothetical treatment or procedure. Some people will even get down to specific types of heart attack procedure or cancer treatment that they want or do not want. The treatment that most people want to address is whether to be fed while in a vegetative state, e.g. living like Terri Schiavo. Clear instructions to your agent in an AMD are essential.

While planning your estate, make sure you take the time to think about an AMD. It is a difficult issue that sometimes requires asking questions about end of life medical treatment and how your loved ones will react to those decisions. However, it will go a long way to giving you piece of mind.

Estate of the Month: Gary Coleman...make sure you update your Estate for Life Changing Events

On May 28th, Gary Coleman, the childhood star of "Different Stroke," died at a hospital in Provo, Utah, when he suffered a brain hemorrhage after falling at his home. Though he touched many Americans as a child actor, his life after "Different Strokes" was troubled, resulting in numerous lawsuits with his parents, fraud and fragile health. In fact, Coleman died almost penniless, but, given his previous fame, he certainly had potential to earn millions in royalties and licensing fees if marketed appropriately. Unfortunately, what has happened after his death and the decision to take him off of life support are unsettling.

Here is a quick background on Gary Coleman's estate. Coleman was married to Shannon Price in 2007 but subsequently was divorced in 2008. Price claims they lived together as common-law husband and wife, even after the divorce. (Click here for more information common-law marriages). After his death, Coleman's parent's attempted to open his estate for probate, stating there was no will and stopping Price from holding his funeral. However, Coleman's ex-manager, Dion Mial, came forward with a 1999 will naming him as the executor in charge. Another will appeared, executed in 2005, naming Coleman's female friend and former companion, Anna Gray, as the one to be in charge of his estate. Price alleges there was a handwritten codicil to the 2005 will, drafted in 2007, naming her as the executor and the beneficiary. Needless to say it is a giant mess, just staring down the barrel of years of estate litigation.

The issue that I find interesting is Coleman's Advanced Medical Directive, or AMD. He appointed Price as his agent to act in his place with respect to his medical care, if he was unable during their marriage, but never updated it after their divorce. It was the AMD that allowed Price to terminate Coleman's life support one day after his fall. His AMD stated that he wanted "life to be prolonged as long as possible within the limits of generally accepted health care standards." Coleman's living will also demonstrated what medical treatment he wanted. In his living will, Coleman gave specific instructions to remain on life support for at least 15 days, if he ever fell into an irreversible coma.

I do not know the specifics of Coleman's condition at his death, but you could argue that Price terminated Coleman's life support much earlier than Coleman wanted. The 15-day waiting period instruction can be overcome if remaining on life support is deemed fruitless, but only a family member could force the issue. Price's "tenuous" relationship to Coleman would make it unlikely she would be considered a "family member.". Maybe everyone acted with Coleman's best interest, but given the amount of money at stake, the ex-wife making end of life decisions just creates a level of suspicion in my mind…or maybe I have seen too many movies.

Coleman should have made sure his estate planning documents, durable powers of attorney, and his AMD's were all up-to-date when living changing events occurred, including getting married, getting divorced, having children or major financial occurrences arising. Also, he should have had any old estate planning documents destroyed. That would have stopped the opening of his estate by his parents and the appearance of mysterious wills from out of nowhere trying to make claims on his estate. He should also have had conversations with those around him ensuring they knew what steps should be taken at the end of his life to meet his wishes. It looks like his death, and events after his death, will mirror his life…troubled by disconcerting actions by those around him.

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