Authors: Richard C. Barry, Jr., Esq.
Winter 2010 - As of January 1st of this year, the federal estate tax is no longer in effect. However, the demise of the tax will undoubtedly be fleeting. It will return either on January 1, 2011, or perhaps sooner, including retroactively to January 1st of this year.

First, a little history concerning the federal estate is in order. Prior to 2001, the federal estate tax exemption was $675,000 and the top tax rate was 55%. If a taxable estate exceeded $675,000, and did not pass to a surviving spouse, then the excess amount was subject to the tax. In 2001, the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) was passed by Congress. Under the law, the top tax rate was eventually reduced to 45%, and the exemption amount was increased as illustrated in the following chart.

YEAR - FEDERAL EXEMPTION
2002 - $1,000,000
2002 - $1,000,000
2004 - $1,500,000
2005 - $1,500,000
2006 - $2,000,000
2007 - $2,000,000
2008 - $2,000,000
2009 - $3,500,000

In 2010, the federal estate tax is repealed under EGTRRA. However, EGTRRA expires on December 31, 2010. This means that on January 1, 2011 the tax law which existed prior to 2001 automatically comes back into existence. Under the pre-EGTRRA law, the federal estate tax exemption would be $1,000,000 in 2011.

When EGTRRA passed in 2001, the repeal of the federal estate tax in 2010 was viewed as a first step toward permanent repeal of the tax, and it was expected that future legislation would make that happen. Eventually, it became apparent that such legislation would not be forthcoming, and it was widely assumed by estate planning attorneys that prior to 2010, legislation would “fix” the federal estate tax. After all, how could a tax be repealed for one year, and then the following year come back with an exemption level $2,500,000 less than it had been two years earlier? And, in fact, bills had been filed in Congress during 2009 which would continue the tax with the $3,500,000 exemption, or with the $2,000,000 exemption which was in effect in 2008. To everyone’s surprise, Congress failed to enact any of these bills.

Congress has indicated that it is likely to pass legislation which would impose the federal estate tax in 2010 and which would be retroactive to January 1, 2010 (previous court cases support the constitutionality of the retroactive effect of tax law), thereby revoking the repeal of the tax in 2010. But, it’s certainly possible that Congress will again fail to enact any legislation in 2010. By doing nothing, the federal estate tax returns in 2011 with a lower exemption amount and higher tax rates. This happens without Congressmen having to make a politically difficult vote on tax legislation.

Ironically, the federal gift tax was not repealed under EGTRRA and remains in effect in 2010 with an exemption amount of $1,000,000. Thus, a person cannot avoid the federal estate tax by giving away the bulk of his or her wealth in 2010. If the repeal of the tax does survive 2010, a person can avoid the tax only by dying in 2010.

In addition, there is the Massachusetts estate tax, which became law in 2003 and will remain in force. All taxable estates which exceed $1,000,000 and do not pass to a surviving spouse are subject to the tax. The tax rates are graduated ranging from .8% to 16%.

Each person has the exemption amounts described above available to his or her estate. This means that a married couple, with proper planning, could shelter as much as $7,000,000 from the federal estate tax when the exemption is $3,500,000, and $2,000,000 if the exemption is reduced to $1,000,000 in 2011. The mechanism to implement such planning is known as the A/B Trust or the Marital Deduction/Credit Shelter Trust. Instead of leaving his or her entire estate directly to his or her spouse, each spouse leaves his or her estate to a trust for the benefit of his or her spouse. The trust divides into Trust A and Trust B. Trust B is funded first with an amount equal to the federal estate tax exemption in effect at the time of the person’s death. Thus, if husband (H) died in 2009 with a $4,000,000 estate, the first $3,500,000 would go into Trust B, and the remaining $500,000 would fund Trust A, which qualifies for the marital deduction. There will be no federal estate tax due upon H’s death, and only the assets in Trust A will be included in the taxable estate of the wife (W) when she later dies.

In order to address the Massachusetts estate tax, Trust B further divides into a Mass Exempt Trust and a Mass QTIP Trust. The Mass Exempt Trust is first funded with an amount equal to the Massachusetts exemption amount ($1,000,000), and the excess goes into the Mass QTIP Trust which qualifies for the marital deduction under the Massachusetts estate tax. Using the above illustration, the first $1,000,000 of Trust B is placed in the Mass Exempt Trust, and remaining $2,500,000 is allocated to the Mass QTIP Trust. There is no Massachusetts estate tax due upon H’s death, but the assets in the Mass QTIP Trust will be included in the Massachusetts taxable estate of W when she later dies.

The A/B Trust used by Fletcher, Tilton & Whipple, P.C. has taken into account the possible repeal of the federal estate tax. The Trust provides that if there is no federal estate tax, then the entire Trust is allocated to Trust B, and Trust B will address the Massachusetts estate tax by dividing into the Mass Exempt Trust and the Mass QTIP Trust. Hence, all of our clients who executed or amended A/B Trusts since 2003 do not need to take any action because of the possible repeal of the federal estate tax in 2010.

Again using the above illustration, if H dies in 2010 and the repeal of the federal estate tax remains in effect, under Fletcher, Tilton & Whipple’s A/B trust, the entire $4,000,000 will be allocated to Trust B. $1,000,000 will be placed in the Mass Exempt Trust and $3,000,000 will be put in the Mass QTIP Trust. When W later dies, none of H’s Trust will be included in her taxable estate for federal purposes, but $3,000,000 will be included in W’s Massachusetts taxable estate.

Anyone considering putting an estate plan in place or updating their current estate plan should not procrastinate due to the uncertainty regarding the federal estate tax. There is no uncertainty about the Massachusetts estate tax, and the federal estate tax will certainly be in place in 2011, if not sooner, with only the exemption amount not known.