In 2001, Congress passed an act that temporarily eliminated the estate tax for the year 2010.  None of us who practice in this arena ever thought that Congress would allow this one year “repeal” to stand. Towards the end of 2009, both houses passed bills reinstate the tax, but nothing ever became law.  While this sounds great, danger lurks within previously drafted estate documents.

I have been very concerned about the impact of this on our middle class clients.  What would happen, I thought, if someone passed away in 2010 with estate planning documents designed around the pre-2010 law?  After all, no one ever expected the 2010 estate tax repeal to actually go into effect.

Earlier this year, my fears were born out.  Jack and Jill were in their 80’s.  They lived on rents from some valuable rental properties they have owned for over 40 years.

Their trust was designed to put the maximum amount of the estate (up to $3.5 million in 2009) about 75% of their estate, into a Decedent’s Trust upon the first death.  This way, when one of them (Jack or Jill) passed away; the real estate would have stepped up to fair market value on the date of death. Assuming Jill died in 2009 or 2011, more depreciation could be deducted and, if the property was sold soon after the death, there would have been no estate tax and no tax on a capital gain.  Translation – the heirs could have sold the property at fair market value and paid little or no tax if Jill passed away in 2009 or 2011.

When Jill died in 2010, following the provisions of their trust, here’s what is supposed to happen:

1)      The maximum amount exempt from estate tax goes into the decedent’s trust.  In 2010, that means everything.

2)      Jack’s estate cannot take advantage of the step up in basis when he passes away after 2010 because all his assets have been distributed out of his estate to the Decedent’s Trust.  Thus, if the heirs sell the property out of the Decedent’s Trust, the taxable gain will be about $3.2 million!

What can we learn from this?

It is June and Congress has not acted on this.  It is probably a good idea if you or someone you know owns highly appreciated property to have an emergency 2010 provision added to the estate planning documents.  Also, if there is a complex estate with different beneficiaries of the various sub-trusts, a “2010 Fix” is probably needed.

For a “primer” on estate planning, read the article “Estate Tax.”  Always contact a professional experienced in this area of practice if you need assistance.

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