DACA Financial Group

The temporary repeal of the federal estate tax and the generation-skipping transfer (GST) tax in 2010 has created uncertainty for families that, in prior years, would have been unaffected by these taxes. Further adding to this dilemma is the likelihood that Congress will reinstate these taxes in 2010, possibly retroactive to January 1. Here is a brief recap of what we do and do not know, along with some issues and opportunities to consider.

What we know

• The federal estate tax and the GST tax (a separate tax on lifetime or at-death transfers to “skip” generations, such as grandchildren) are repealed for 2010, but are set to reappear in 2011 at pre-2001 rates. In 2011, the estate and GST tax exemption amounts will drop to $1 million (from $3.5 million in 2009) and the highest tax rate will jump to 55% (from 45% in 2009).
• The gift tax remains in place with a $1 million lifetime exemption and a tax rate of 35% (down from 45% in 2009).
• In prior years, inherited assets received a step-up in cost basis to the asset’s fair market value on the date of death. In 2010, inherited assets generally receive the lesser of the asset’s date-of-death fair market value or the decedent’s carryover basis. However, estates can exempt up to $1.3 million of gain for assets left to heirs, and an additional $3 million exemption can be allocated to assets specifically left to a surviving spouse.

What we don’t know

• Will Congress reinstate the estate and GST taxes at their 2009 levels, or will they create a new tax regime?
• Will any changes be retroactive to January 1?
• How will estates be expected to pay any retroactive taxes, especially if assets have already been distributed?
• What will individual states that link their own estate tax systems to the federal estate tax system do?

Issues and opportunities

It’s hard to know how to react to the uncertainty presented by the current estate tax situation. Should you change your estate plan and update your estate planning documents when it’s possible that your existing plan will once again be appropriate in 2011, or even sooner? For many, the answer is no, but for a few, the answer is definitely yes.

Generally, you should consult an estate planning attorney if:

• You are very old, very ill, or terminally ill
• You have a will or trust that allocates assets based on a “formula clause”
• You want to make gifts to individuals in the “skip generation”–those who are two or more generations below you
• You have assets with an appreciated value in excess of $1.3 million

Aged or ill need to review estate plans now

For those who are aged or terminally ill, if the repeal remains effective, your goal may shift from saving estate taxes to saving capital gains taxes. Thus, in response to the modified step-up in basis provision, you may want to reallocate the distribution of highly appreciated assets.

Your will or trust should authorize your executor or trustee to allocate the $1.3 million basis adjustment and the $3 million spousal basis adjustment in the most advantageous way, while allowing for the possibility of the reappearance of the estate tax. However, determining how to do so can vary greatly based on many different factors, including:

• Your cost basis in estate property and the amount of gain that would be realized if the property is sold in 2010
• The anticipated tax bracket of the beneficiary inheriting the property–the tax impact may not be as great for beneficiaries in a lower tax bracket
• Whether appreciated property placed in a bypass trust qualifies for the surviving spouse’s basis adjustment
• Whether property is expected to be retained by the beneficiary after it’s inherited, such as a farm or family business
• Whether capital gains tax can be avoided or minimized through other means, such as charitable gifting
• Whether the $250,000 federal income tax home sale exclusion applies to estate property that is a principal residence

Review documents for formula clauses

Your will or trust may provide that upon your death, a percentage or fraction of your estate, up to the applicable estate tax exclusion amount, will pass to a family trust (also referred to as a bypass or credit shelter trust) for the benefit of your children, with the balance going to a marital or residuary trust for the benefit of your surviving spouse.

If there is no estate tax at your death, such a formula clause may cause your entire estate to be transferred to your family trust, leaving nothing to the marital trust. If your surviving spouse is the beneficiary of both trusts, there may be no problem, but if your spouse has no right or access to assets in the family trust, then your surviving spouse could be unintentionally disinherited.

In light of these potential issues, it is best to review your estate planning documents with your attorney and make necessary revisions to ensure that your wishes are carried out. Your will or trust should be drafted to clearly reference what should happen if you die when there is no estate tax, or if the exclusion amount is greater or lesser than the 2009 amount ($3.5 million). Your documents will need to provide flexibility in their distribution provisions to accommodate the possibility of many varied scenarios.

If you’re inclined to make large gifts

The temporary repeal of the GST tax provides an opportunity to make gifts to skip beneficiaries free from the GST tax. You can make large gifts to grandchildren, subject only to the gift tax (at a 35% tax rate). If you don’t want to make a gift directly to your beneficiaries, you can gift to a dynasty trust which directs when beneficiaries are able to access their gifts. However, if the GST tax is imposed retroactively, some of those gifts may be subject to that tax after all. You’ll have to weigh this possibility against the potential tax savings of gifting without the GST tax to determine the best course of action for you.

If you’ve already begun a plan of gifting to grandchildren, either directly or through dynasty trusts, you should review your estate plan. If gifts to your grandchildren are based on your available GST tax exemption, those gifts may not be made if you die in 2010 when the GST tax is repealed. An estate planning professional may be able to amend your documents to include a different formula to account for the possibility that there is no GST tax exemption when allocating gifts to grandchildren.

What about state estate taxes?

Some states have their own estate tax, and many estate plans were drafted in contemplation of either or both a federal estate tax and a separate state estate tax. These plan documents also need to be reviewed in 2010. Your will or trust may direct that assets be allocated to a family or bypass trust to minimize the federal or state estate tax, when the capital gains tax is also a real possibility. How should assets be allocated now to take advantage of the repeal of the federal estate tax, to minimize any potential capital gains tax, or to utilize any state estate tax exemption? These questions require careful consideration and planning as there’s no “one size fits all” solution.

Conclusion

The tax law changes in 2010 have given rise to much confusion and many issues to consider. Inaction is the least favorable option. Keep abreast of the potential legislative changes that might occur in 2010 and work with your estate planning professional to update your plan documents to best carry out your wishes now and in the future.

Forefield Inc. does not provide legal, tax, or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or for the accuracy of information provided by other sources.

Prepared by Forefield Inc. Copyright 2010.

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Health-Care Reform: Considerations for Seniors The enactment of the new health-care reform legislation contains some provisions that directly affect our nation’s older population. If you’re a senior, you may be concerned about how these reforms may affect your access to health care and the benefits you are currently receiving. Medicare spending cutsNot surprisingly, the concerns of retirees and seniors generally center on potential cuts in Medicare benefits. At the outset, the new legislation does not affect Medicare’s guaranteed benefits. However, a goal of the new health-care legislation is to slow the increasing cost of Medicare premiums paid by beneficiaries, and to ensure that Medicare will not run out of funds. To help achieve these goals, cuts in Medicare spending will occur over a ten-year period, beginning in 2011, particularly targeting Medicare Advantage programs––Medicare programs provided through private insurers but subsidized by the federal government. These cuts could reduce or eliminate some of the extra benefits Medicare Advantage plans may offer, such as dental or vision care, and some insurers may choose to increase premiums. But Medicare Advantage plans cannot reduce primary Medicare benefits, nor can they impose deductibles and co-payments that are greater than what is allowed under the traditional Medicare program for comparable benefits. And, some of the federal funds previously earmarked for Medicare will be reallocated to doctors and surgeons as an incentive to treat Medicare patients. Medicare Part D drug program changes Some Medicare Part D beneficiaries are surprised to find that they have to pay for the entire cost of prescription drugs out-of-pocket after reaching a gap in their annual coverage, referred to as the “donut hole.” Currently, if you’re a Medicare Part D beneficiary, you may pay up to an additional $3,610, out-of-pocket, for medicines after reaching an initial threshold of $2,830 in total prescription drug costs (including Part D payments, beneficiary co-pays, and deductibles). But, beginning in 2010, beneficiaries who fall in the donut hole will receive a $250 rebate, and, in 2011, they will receive a 50% discount on brand-name drugs. By 2020, a combination of federal subsidies and a reduction in co-payments will completely eliminate the donut hole. However, individuals with annual incomes greater than $85,000, and couples with incomes exceeding $170,000, will see their Part D premiums increase as the federal subsidy offsetting some of the cost of Medicare Part D premiums is reduced. Benefits added to Medicare The leglislation also improves some traditional Medicare benefits. For example, Medicare beneficiaries will receive free wellness and preventive care beginning in 2011. Increased access to home-based care Often, people with disabilities or illnesses would rather receive care at home instead of at a hospital or nursing home. The new health-care reform law provides for programs and incentives for greater access to in-home care. The Community Living Assistance Services and Support program (CLASS) will be established sometime after 2011 (depending on when final regulations are published) as a voluntary insurance program, financed through payroll deductions and available to all working adults who choose to participate. This national program allows participants with functional limitations to maintain their personal and financial independence and live in the community by providing a cash benefit of at least $50 per day (after a five-year vesting period) for nonmedical services, such as home-care services, family caregiver support, and adult day-care or residential-care services. In order to qualify, a participant must need help with at least two activities of daily living, such as eating, toileting, transferring, bathing, dressing, or continence. Also in 2011, the Community First Choice Option will be available to states to add to their Medicaid programs. This option will provide benefits to Medicaid-eligible individuals for community-based care instead of placement in a nursing home. In addition, the State Balancing Incentive Program, to be established in 2011, will provide increased federal funds to qualifying states that offer Medicaid benefits to disabled individuals seeking long-term care services at home, or in the community, instead of in a nursing home. The Independence at Home demonstration program, available in 2012, will be a test program that provides Medicare beneficiaries with chronic conditions the opportunity to receive primary care services at home. That is intended to reduce costs associated with emergency room visits and hospital readmissions, and generally improve the efficiency of care.

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Forefield Inc. does not provide legal, tax, or investment advice. All content provided by Forefield is protected by copyright. Forefield is not responsible for any modifications made to its materials, or for the accuracy of information provided by other sources.

Prepared by Forefield Inc. Copyright 2010.

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