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The failure of Congress to address the scheduled, short-term expiration of the Federal Estate and Generation Skipping Transfer taxes has created a period of confusion and uncertainty for families and their wealth managers. Even if Congress enacts legislation in 2010 to continue the taxes, there will remain questions about any retroactive application of such legislation. Baker Hostetler has been monitoring these developments closely and has begun to counsel existing and prospective clients regarding how best to respond to these developments.

Background: The federal government imposes three taxes on the transfer of wealth: (1) a Gift tax on lifetime transfers, (2) an Estate tax on transfers at death and (3) an additional Generation Skipping Transfer (“GST”) tax on transfers during life and at death when the transfer is to persons in a generation younger than the donor’s children. For all of 2010, unless there is earlier Congressional action:

• The Estate and GST taxes are repealed;
• The Gift tax will continue in 2010, but at a 35% rate rather than the current 45% rate; and
• Although there is no Estate tax, estates of decedents and their beneficiaries are potentially subject to capital gains taxes that historically would have not applied due to basis “step-up” rules.

How This Happened: Legislation passed in 2001 phased out the Estate and GST taxes beginning in 2001. Over time the amounts exempt from the Estate and GST taxes were increased and the rates were decreased. In 2009 the exemption amount was $3.5 Million and the rate was 45%. The 2001 legislation repealed these taxes but only for 2010. Because of procedural budget rules in the Senate, the 2001 legislation expires at the end of 2010. In the absence of further Congressional action, these taxes will be reinstated in January 1, 2011, at pre-2001 exemption amounts ($1 Million) and rates (maximum 55%).

Congressional Inaction: The House of Representatives recently passed legislation that would permanently retain the Estate and GST taxes at the 2009 exemption amount and rate but the Senate was unable to consider an extension before it adjourned for the year. Senate Finance Committee Chair Max Baucus has noted he intends to takes steps early in 2010 to extend the Estate and GST taxes retroactive to the end of 2009. However, for several years there has been political division over whether the taxes should be repealed or retained, and, if so, at what level of exemption and at what rate. It is unclear whether Senator Baucus will be able to attract sufficient support from his Senate colleagues, or the agreement of the House of Representatives, if the Senate considers anything other than the permanent extension of the 2009 exemption amount and rate. Moreover, the outcome is clouded by political obstacles and the uncertainty of whether Congress, constitutionally, may impose these taxes retroactively to the end of 2009.

Suggested Client Responses: Families should not wait for Congress to act. They should:

• Review their current estate plans to be sure there is adequate flexibility to address the potential application of capital gains taxes to inherited assets;
• Carefully consider any transfers defined by formulations which reference or assume there is an Estate and/or GST tax;
• Consider the advisability of making gifts at the lower 35% rate, particularly generation skipping gifts, prior to Congressional consideration of the matter; and
• Factor the potential retroactive nature of any new rules on actions taken during this period of uncertainty.

In all events, families should consider large-scale gifting during this period of uncertainty only with the aid of knowledgeable professionals. Baker Hostetler’s nationwide team of private wealth and tax counsel will continue to monitor these developments and are available to explain the various planning choices available to individuals and their families.

Baker & Hostetler LLP publications are intended to inform our clients and other friends of the Firm about current legal developments of general interest. They should not be construed as legal advice, and readers should not act upon the information contained in these publications without professional counsel. The hiring of a lawyer is an important decision that should not be based solely upon advertisements. Before you decide, ask us to send you written information about our qualifications and experience. © 2009 Baker & Hostetler LLP